Indian tech firms are trading extremely volatile this week after TCS and Infosys reported lower-than-expected fourth-quarter earnings. Wednesday was no different as most IT stocks were in the red as HCL Tech’s Q4 earnings were in focus. It is expected that TCS and Infosys are not the only ones to see a slowdown in US performance, with others likely to follow suit in the last quarter of FY2023. But not only this, the banking crisis in the US and Europe is expected to impact Q1 FY24 as well.
Kotal Institutional Equities said in its report, ‘The slowdown was faster than expected. Infosys And TCS North America reported qoq revenue declines of 3.8% and 0.8%, respectively. Revenue declines in North America were on a sequential basis across all verticals. Due to the decline there were pauses and even cancellations of discretionary programs. After a slow start in January, projects were put on hold/cancelled in February and this continued in March. banking crisis More caution in US regional banks and European banks in March 2023 and this may impact the June 2023 quarter.”
“We would not be surprised by a weaker US performance across all companies that are likely to report in the coming days,” the brokerage said.
For FY24, Kotak said, the fiscal projections should have been weaker and should have played out as such. What is important for valuation is a look at structural growth drivers, i.e. whether growth will accelerate above pre-existingcovid level in FY2025?
“The current slowdown will raise questions about the sustainability of long-term digital transformation spend,” Kotak’s note explained. Supporting the creative approach is the fact that cloud workloads are still at 30-35% and are yet to reach. An additional 2-3 years would be required.” Desired 60-70% level.”
The brokerage expects the adoption of cloud-native applications to increase as more IT workloads move to the cloud. There are lots of exciting technologies, such as IoT, Big Data and Deep Learning AI, that lend themselves well to cloud environments. Analytics and Big Data are already being adopted on a large scale in the cloud. These can sustain healthy growth for IT services beyond the cloud migration phase.
With regard to margins of IT companies in FY24, Kotak’s note said, “We see margin increase for most Tier 1 in FY24, driven by the supply side and levers such as utilization and pyramid can be flexed. However, we underestimated flex. In FY2024. The current demand environment has not broken, with several large cost deals and programs underway with near-term ROI. As a result, companies are willing to bear additional costs including wage increases so that they don’t lose out in the event of a surge in demand. At the same time, customers are pausing discretionary programs.”
These factors limit the usefulness and potential for quick fixes in the pyramid.
In the past, companies expanded margins when recessions hit. Kotak highlighted that the reason for this was straightforward – there was complete clarity of demand destruction in previous recessions like GFC and Covid.
It said, “As a result, companies quickly aligned cost structures, something that is not the case in the current environment. Taking these factors into account, we now assume margin stability in FY2024 and growth in FY2025.”
However, the brokerage does not expect a deep downturn in its base case values for Indian IT firms.
Kotak’s note said, “We do not consider a deep recession in our valuation base case. The growing possibility of a recession poses a risk to multiples. Better payout ratios of IT companies, full participation in the digital journey of customers and medium term Legs to growth. Completion of customers’ digital transformation journey means the stock could trade for multiples higher than in the pre-recession, assuming the same cost of equity as in the past. Stock valuations not baked into recession Happens, but builds in recession.”
“TCS and Infosys are best positioned. HCLT and LTIM can benefit in select cases. Similar cost extraction opportunities, but can be addressed by a larger pool of companies among smaller enterprises. Many other companies in the space struggle Will do – growth among leaders and laggards should continue in FY2024 and beyond,” the brokerage’s note concluded.
Disclaimer: The views and recommendations given above are of individual analysts or broking companies and not of Mint. We advise investors to do due diligence with certified experts before making any investment decision.
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