IT stocks on road to revival, may be dark horse this year

Information technology (IT) companies have been on the road to revival in the past one year. From being the worst-hit sector in 2022 with a loss of 26 per cent, the Nifty IT index closed 2023 with gains of 24 per cent.

So far in 2024, the index is up around 7 per cent against the nearly flat Nifty 50 benchmark index.

The IT index has been on a continuous decline in the last three sessions.

This comes after surprisingly hotter-than-expected inflation in the US recently pushed back bets of imminent rate cuts by the US Federal Reserve (Fed).

Most global traders now expect the first Fed rate cut to be announced in June against earlier bets of March.

Analysts, however, believe that at current valuations, there is still steam left in IT stocks before rate cuts play out this year. The pocket, thus, can emerge as the dark horse by 2024-end, they say.

Rate cuts will be positive for IT companies as improved spending by corporates will lead to higher deal wins and especially lift the largest revenue-accruing banking, financial services and insurance (BFSI) vertical.

Demand for new tech like artificial intelligence (AI), Cloud and automation along with transformation deals will also aid growth. Valuations are neither extremely attractive nor overstretched.

They are at mid levels, so one can invest in a staggered manner at the current levels, said Nirvi Ashar, research analyst at Religare Broking.

During the December quarter, IT earnings beat low expectations of the Street with companies covered by Motilal Oswal Financial Services (MOFSL) delivering a median quarterly revenue growth of 1 per cent in constant currency.

As weakness persisted in key verticals, companies slightly narrowed their revenue guidance but spoke of green shoots in discretionary spending.

Some pockets like consulting in Wipro, were the silver linings, according to analysts.

Expectation of Fed rate cuts could boost client budgets ahead, even as this seems difficult at present.

This has led us to build in annual revenue increases of 7 per cent and 10 per cent for IT largecaps, and 14 per cent and 16 per cent for midcaps in FY25 and FY26, respectively, wrote Devang Bhatt, research analyst at IDBI Capital, in a review report.

Those at MOFSL also expect the IT sector to drive incremental earnings for FY25, after banks and metals.

Technology sector will be among the key earnings drivers with 15 per cent on-year earnings growth in FY25,  they said.

However, the current January-March quarter is likely to be soft amid deal execution pressure, suggesting near-term weakness, experts said.

Q4 outlook doesn t suggest immediate recovery.

Margin beats in Q3 were driven by up-fronting of levers with aggressive cuts in sub-contracting/staff cuts.

This could come back to bite as growth recovers in FY25 and utilisation leverage plays out by Q4 itself, wrote analysts at Ambit Capital in a recent note.

They expect modest growth improvement for the IT sector in FY25 but a decline in Tier-1 margins.

This is contrary to Street hopes of an expansion.

Prefer turnaround plays like Tech M, Cognizant or those with better segmental skew like HCLTech.

Like Infosys over TCS on cheaper valuations and risk of growth versus margin trade-off at the latter, Ambit analysts said.

Those at IDBI Capital prefer Wipro and Infosys in largecaps and Sonata, Newgen and Cyient in midcaps.

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