Expect Faster Growth From Mid-Sized IT Cos

But there would be greater safety in the larger ones.

The IT sector could be a hedge against the generally worsening macro situation for the Indian economy.

It has a reverse correlation with the rupee.

If the rupee weakens, the IT industry gains since the earnings are primarily in hard currencies while a large proportion of its expenditures are in rupees.

The industry has also gained from digitisation forced by work from home, movement towards cloud-based services, and dematerialisation, among others.

Both the growth rates and guidance by companies have remained robust, despite the Russian invasion of Ukraine and its negative impact on global growth rates.

There is a consensus that demand is not just pent-up spending, which was deferred in the early stages of the pandemic.

Digitisation is sustainable for the medium-term.

In constant rupee terms, the IT services industry could log 12 per cent revenue growth in the next fiscal and beyond.

While most IT firms have complained about margin pressures and high churn, these may be stabilising and pricing improvement is possible in the medium-term if US growth remains strong.

While the Nifty is down marginally in the past month, the IT Index is up by 2 per cent.

The IT Index is more highly valued than the Nifty50, however, and the Nifty itself is also objectively quite highly valued.

The IT index is trading at a price-to-earnings (P/E) ratio of 35 times (last four quarters) whereas the Nifty is at 22x.

The premium valuation over the general market is easily justified, given the protection hard-currency earnings and growth visibility offers.

It is more speculative to judge if current levels overvalue the likely earnings growth.

However, the market is clearly assigning higher valuations and upgrading the industry's FY23 prospects.

Compared with other major sectors, the IT industry has seen better valuations and rerating.

One analysis makes an interesting point. In terms of P/E, the IT index was trading at 20x in December 2019. It is at 35x now.

However, EPS annual growth over 2019-2021 ran at around 11 per cent.

But EPS CAGR is expected to improve to around 22 per cent between FY22 (base) and FY24.

So, the sharp rise in valuations may be justifiable if done in terms of price/earnings-to-growth (PEG).

Indeed, in terms of PEG, the IT sector is trading at a lower valuation to expected forward EPS.

Mid-caps are also trading at premiums to large-caps.

The US-listed Accenture, which is in many respects comparable to Indian IT services companies, has just released strong quarterly results and guidance.

Outsourcing revenue grew strong (up 2.3 per cent sequentially and 19 per cent YoY) along with robust outsourcing bookings ($8.7bn, up 17.6 per cent QoQ).

Accenture upgraded its FY22 revenue growth guidance yet again to 24-26 per cent YoY in local currency, a huge growth estimate.

Growth was good across all regions and segments.

In comparison, the guidance of Indian rivals appears conservative.

In the last month, the best performers among the Indian Nifty IT index include Infosys (up 7.5 percent), Wipro (7 per cent rise), L&T Technology Services (up 4 per cent) and Tech Mahindra (3.95 per cent increase).

Only Tata Consultancy Services (down 3.7 per cent) and Coforge (down 2.5 per cent) are losers.

Investors could expect faster growth from mid-sized firms, but there would be greater safety in the larger ones.

Feature Presentation: Aslam Hunani/Rediff.com