Is the fall in information technology stocks overdone?

After a sharp correction over the last few months, analysts seem to be turning cautiously optimistic on the information technology (IT) sector and suggest there could be trading opportunities in select counters despite revenue and growth concerns that still plague the sector.

“IT stocks valuations have corrected 17 per cent-49 per cent and stock prices have corrected 9 – 42 per cent since mid-December 2021. Nifty IT index valuation has corrected by 27 per cent and price by 21 per cent.

"About two quarters ago, we made a case that valuation drivers have peaked.

"Looking at the same drivers, we now believe that valuations are in a reasonable band,” said Sushil Sharma, an analyst at Edelweiss Wealth Research.

In the last few weeks alone, analysts at JP Morgan, Kotak Institutional Equities (KIE) and Nomura had sounded caution on the sector, suggesting that the heydays of the IT sector may be over, at least for now.

Despite the caution, most do agree that there are stock-specific opportunities within the sector.

JP Morgan, for instance, still maintains an overweight rating on Infosys due to its growth potential, Tech Mahindra for the 5G cycle (telecom) and margins expansion, MphasiS and Persistent Systems on account of exposure to the defensive industries amid stronger growth outlook.

Meanwhile, the Nifty IT index – a gauge of the performance of IT stocks on the NSE – has been the worst sectoral performer, falling around 19 per cent thus far in fiscal 2022-23 (FY23).

Among stocks, Tata Consultancy Services (TCS), HCL Technologies (HCL Tech), Coforge, Wipro, Infosys and Tech Mahindra were among the top losers that lost 10 per cent to 24 per cent during this period, ACE Equity data show.

At the fundamental level, Sharma of Edelweiss believes that the revenue-cut related earnings impact is still pending for select IT companies, which may play out over an elongated period.

“Consensus estimate is building 12-17 per cent revenue growth for large-caps and 16-22 per cent growth for mid-caps.

"In the near-term, we do not expect revenue guidance cuts in post Q1-FY23 results. We believe management commentaries may become cautious but are likely to re-iterate strong demand outlook.

"Our preferred pick to play IT stocks in near-term is Infosys and Tech Mahindra among the large-caps. L&T Infotech and L&T Technology Services are the preferred mid-cap plays.

"Under volatility / uncertainty, we prefer large-caps / large mid-caps over small-caps,” Sharma said.

In the large-cap universe, analysts at Nomura expect Infosys to post the fastest revenue growth (US dollar terms) at 14 per cent with 100 basis point (bp) compression in EBIT margin to 22 per cent in FY23.

“In its next leg of growth, Infosys focus is on scaling cloud, increasing intensity in digital, next generation seeding EU focus, and new technologies), advanced automation and modernization, and focusing on people care and development.

"We reiterate our ‘buy’ rating on the stock with a target price of Rs 1,720 (set at 25x FY24F EPS of around Rs 69).

"The stock is currently trading at around 22x FY24 EPS,” wrote Abhishek Bhandari, an analyst tracking the sector at Nomura.