Taking stock: Weak guidance, multi-quarter low growth keep IT investors on edge; what’s in store ahead?


Dalal Street investors weren’t expecting any fireworks in IT companies’ first quarter earnings, but the disappointments were worse than anticipated, as growth hit multi-quarter lows.

Frontline IT companies have seen their constant currency revenue growth slow down in the last six quarters, and a majority of them reported just single-digit growth in the June quarter.

Sector bellwether Tata Consultancy Services reported a 7% year-on-year growth in constant currency revenue growth for the last quarter, after seeing 11-15% growth in the preceding four quarters.

Wipro saw just a 1% growth in revenue in constant currency terms in the June quarter after reporting a sharp 17% growth in the same period last year.

Not only sales, but a majority of the companies reported a contraction in their profitability, weighed down by wage hikes and other costs.

Operating margin of Tier-1 companies declined 25-130 basis points sequentially, which was steeper than anticipated by analysts. This was due to unanticipated ramp-downs and project delays, impacting the ability to match costs with revenue.

Pricing pressure from clients in the backdrop of the tough environment further weighed on the margins.

Reality Check
The Street was expecting a cut in the guidance by companies, but Infosys gave a rude shock to investors by saying that sales are likely to grow by only 1-3.5% in FY24, against 4-7% projected earlier.

“Guidance cut by Infosys is sharp, but also reflects the reality of demand on the ground,” said Kawaljeet Saluja of Kotak Institutional Equities.

Meanwhile, TCS and LTIMindtree dialed down expectations of double-digit growth in FY24, indicating that the demand environment remains challenging for all companies.

The sharply lower growth projection amid a bleak outlook for technology spend triggered earnings downgrades for the IT pack.

Outlook Clouded
The two verticals that most IT companies saw notable slowdown were banking and telecom, and these two sectors saw significantly higher digital spend during the pandemic period.

The commentaries by companies indicate that project ramp downs or cancellations might still be on-going as and when these projects come up for renewals.

A point to be noted is that Infosys cut its revenue growth guidance sharply despite bagging about $2 billion worth of large deals in the last quarter, which suggests a likely sustained erosion in the discretionary order book.

“If erosion of the current book of business sustains through FY24, it could result in a weaker exit rate, thus, potentially putting FY25 estimates at risk,” said Abhishek Kumar of JM Financial Institutional Equities in his note.

The brokerage remains cautious on the sector and has a “hold” rating on the majority of the stocks.

Stock Talk
With uncertainties aplenty at the current juncture, the question is whether the sector will find itself at the top of Dalal Street investors’ preferred list?

A section of the market believes that the correction in the valuation of IT companies in the recent months have factored in the expected slowdown in earnings. Therefore, steep correction from current levels may not be seen.

“Although industry valuations have corrected significantly, limiting downside risks, this presents a favourable opportunity for long-term investors to accumulate IT stocks,” said Vinod TP, research analyst, Geojit Financial Services.

Analysts are extremely selective in the sector and want to stick to companies that have the ability to manage the revenue run-rate despite a slowdown in deal wins.

“We prefer companies with strong capabilities, good execution, ability to address both discretionary and cost take-out mandates of clients and available at reasonable valuations,” Saluja said, adding that Infosys fits the brokerage’s thesis the best and is attractive despite the recent sharp upmove.

Meanwhile, correction in the stock price provides a better entry point for HCL Technologies, while risk-reward remains unfavourable for TCS stock, Kotak Equities said.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)


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