19 May , 2022 By : Kanchan Joshi
JP Morgan analysts have downgraded India's IT services industry to "underweight", citing soaring inflation, supply chain issues and the hit from the Ukraine war will bring an end to the growth boom the industry enjoyed during the pandemic.
“Rising margin headwinds in the near term and revenue headwinds in the medium term from a potential macro slowdown will mean that the sector’s earnings upgrade cycle is behind. We see peak revenue growth behind us and EBIT margins trending down from inflation, mean reversion," the analysts said.
“Indian IT growth was accelerating till 3Q22 and has begun to slow down from 4Q22, which is likely to worsen into FY23 amid worsening macro. With peak sector growth behind, growth deceleration should continue to weigh on sector multiple."
The analysts however said that "while the bottom-up outlook remains positive from most Services, Software and SaaS names YTD, and the tech spending cycle remains buoyant structurally, we feel there are more downside risks to current earnings assumptions."
The brokerage expects the slowdown to worsen in 2023 partly due to a potential decline in orders from the key market of United States, where economic growth has started to weaken.
It lowered Tata Consultancy Services Ltd (TCS), India's top IT exporter, to "underweight" rating from "neutral" but stayed "overweight" on rival Infosys. Shares of TCS today slumped over
While industry margins are expected narrow because of a talent war that has pushed up costs of hiring and retaining employees, Infosys' margin reset is early and gives it bandwidth to invest and maintain growth, JPM said.
IT stocks have corrected despite a relatively strong demand environment and robust revenue growth guidance, according to Kotak Institutional Equites.
According to Kotak, “correction has been driven by three factors—(1) increase in interest rates, (2) fears of recession in key client geographies and (3) risk to margins."
The brokerage says “what is priced into stock is risk to margins. What is not priced in is economic recession. "
Infosys and HCL Tech are top picks of Kotak while in midcaps it likes Mphasis.
Kotak says that onsite operations to get costlier for Indian IT companies with increasing supply shortage and inflation. “US tech unemployment rates hit record low of 1.3% in the month of March and continued to trend below 2% in April indicating a severe resource crunch. This coupled with high attrition and inflation could lead to higher wage costs and subcontractor dependence for IT services companies," the brokerage said.
Commentary of large IT services players, leading hyperscalers and software vendors largely indicate that the demand environment is robust as of now, said Kotak.
“However companies are wary of macro headwinds and are planning for different scenarios. The implication for technology spending will be different for a growth slowdown and a recession."