For IT firms, the Covid-led trend of work from home (WFH) came as a blessing in disguise. A growing emphasis on digital transformation and cloud adoption aided in impressive earnings growth, leading to a sharp rally in IT stocks. It is no surprise that the Nifty IT Index has been one of the best performing sectoral indices over the past year. With returns of around 90%, it has comfortably outperformed the Nifty 50 index, which has gained 52% in the same period.
Data compiled by Motilal Oswal Financial Services Ltd shows that with a significant jump in the market capitalization of the sector, its weightage in the Nifty 50 index has touched a multi-year high of 18%. This optimism has also rubbed off on valuations. Motilal Oswal said in a report on 7 September that the one-year forward price-to-earnings multiple of the sector is 30 times, the highest in the last 15 years.
“The multi-year high weightage of the IT index and peak valuations are both tied to the strong earnings growth of technology companies and their resilience during the pandemic. Kumar Rakesh, Senior Auto and IT Analyst, BNP Paribas India, said, “Last year at the peak of the impact of the pandemic, IT companies saw year-on-year (y-o-y) EBIT growth when companies in other sectors were severely affected. impressed by it.” Ebit is short for earnings before interest and tax.
see full image
In Q1FY22, major IT services firms saw strong dollar revenue growth on a sequential basis, aided by geographic and broad-based growth in services. In addition, management’s comments point to a strong technical spending environment. As far as deal wins are concerned, analysts say the average book-to-bill increased from 1.2x in Q1FY21 to 1.3x in Q1FY22 and provides strong growth visibility for FY22.
Rakesh further added that the IT sector has been the beneficiary of the WFH culture, which has led to greater digital transformation among customers and in turn has started a multi-year growth cycle for the sector. So, if there is another wave, the IT sector is likely to be less affected, he added.
That said, the sector is not completely protected from some other downside risks. One of them is margin compression due to increased supply-side pressure on high demand talent. In the June quarter, operating margins for several IT firms declined 80-200 basis points sequentially, primarily impacted by wage growth and employee growth. One basis point is one hundredth of a percentage point. On a yearly basis, margins are higher due to lower travel expenses, but discretionary spending will return as normalcy resumes.
Second, investors will also be watching closely the winning structure of future deals. The deal-win pipeline runs the risk of being skewed, with a handful of sectors driving the momentum, including the banking and financial services (BFS) and healthcare industries. In the June quarter, Indian IT firms posted strong sequential growth in the BFS vertical. For Infosys, nine out of 22 big deals were in financial services in 1QFY22. L&T Infotech and Mphasis posted strong sequential growth of 9.9% and 8.4% respectively in the BFS vertical in the latest quarter.
However, valuations of the sector will remain elevated on expectation of continuation of strong demand momentum. “The comments on growth are largely status quo, while supply pressures remain high. Analysts at Ambit Capital Pvt Ltd said in their recent report, the valuation already constitutes 11-15% USD revenue CAGR for Tier-1 and 15-22.5% for Tier-2. .
Don’t miss a story! Stay connected and informed with Mint.
download
Our App Now!!
.