The technology pack saw fresh selloff on Wednesday after Nomura warned of sharp deceleration in growth rates for the sector as companies scale back their tech spends amid a challenging micro environment. The brokerage downgraded several stocks in the sector and reduced their target prices between 16 and 38 per cent.
Nomura’s report comes just days after JP Morgan warned of “dark skies” for the domestic IT sector as it believed “peak revenue growth behind us and EBIT margins trending down from inflation, mean reversion.”
“We think enterprises’ willingness to spend on digital transformation will continue, but growth rates on spends are likely to decelerate constrained by revenue and earnings volatility. Our study of revenue and earnings profiles of ~750 listed companies, suggests a material slowdown in the overall financial performance in the upcoming quarters. We see a strong correlation between financial performance of the sample set and IT services revenue with a lag of 1-3 quarters (depending on the sector), indicating a potential slowdown for IT services demand in FY24,” said Nomura in a note.
The rally in the IT stocks was underpinned by sharp year-on-year growth in revenues during FY22. The top-tier tech stocks saw an average growth in revenues of close to 20 per cent, while tier-II companies saw a growth of 25 per cent.
Analysts are expecting revenue growth for large-caps to fall to 13 per cent in FY23 and to below 10 per cent in FY24. To make matters worse, even companies are expected to face margin pressures. This has prompted analysts to assign lower earnings multiple.
“In the near term (FY23F), we expect headwinds to be higher than the tailwinds for the sector, notwithstanding the recent depreciation of rupee versus the dollar.
Extremely volatile capital markets and rising interest rates have started to dry up liquidity for start-up companies globally. Rising firing of employees (in an endeavour to save capital and demonstrate a path to profitability) and hiring freeze is also likely to slow down the unprecedented demand for tech talent in the coming quarters, in our view,” Nomura has said.
IT has been one of the best-performing sectors in the post-pandemic era as disruption caused by Covid-19 lockdowns forced companies to automate and increased tech spends. This sent trading multiples for several stocks in the sector to record highs. After this year’s fall, the valuation excesses have come down but analysts believe they are still higher given the change in growth dynamics.
“Indian IT growth was accelerating till 3Q22 and has begun to slow down from 4Q22, which is likely to worsen into FY23 from tougher comps, supply issues and eventually a worsening macro. With peak sector growth behind, growth deceleration should continue to weigh on sector multiples,” says the note by JP Morgan.
“Indian Tech Services are the most expensive services names globally at a premium to digital native peers and Accenture, and at par with enterprise software that appears unsustainable. Sector reverse DCFs suggest that the market is still baking in 6-13% growth for Tier 1s and 14-33% for midcaps over the next decade; that seems optimistic given this remains a late cyclical sector for most names,” the note added.
Among large-caps, JP Morgan has a ‘neutral’ rating on TCS, HCL Tech, Wipro and ‘overweight’ stance on Infosys and Tech Mahindra. Nomura has a ‘buy’ rating only Infosys and Tech Mahindra and ‘reduce’ on TCS, and ‘neutral’ on Wipro and HCL Tech.