scorecardresearchEvolving scenarios signs stress for India's IT sector but experts remain

Evolving scenarios signs stress for India's IT sector but experts remain positive

Updated: 20 Oct 2022, 08:07 AM IST

  • Even though challenges persist, the overall picture is not as gloomy as expected earlier. Or, is it so?

The Nifty IT index has lost over 20% in the last one year.

The Nifty IT index has lost over 20% in the last one year.

The September quarter numbers of most IT players have been broadly on expected lines. There were no negative surprises in numbers, and management commentaries were optimistic too.

Even though challenges persist, the overall picture is not as gloomy as expected earlier. Or, is it so?

The US and the major part of Europe are expected to see a long recession by next year. Both geographical regions are key for Indian IT firms as they are their major markets. It may be a misplaced optimism to believe that all will be alright with IT companies even though the fact remains that IT services are indispensable for business across segments.

The situation has not worsened but there are conspicuous signs of stress.

The Nifty IT index has lost over 20% in the last one year. In 2022 year-to-date (YTD), the IT index has cracked 27%. The benchmark Nifty is down 5% in the last one year and up 1% in 2022 YTD.

Evolving scenario

Aggressive rate hikes have aggravated the risk of a recession in developed economies such as the US and the UK and some other parts of Europe too. In a recession, companies will be forced to cut their spending on several segments, including IT expenses which will simply result in delayed or cancelled orders and a shrinking order pipeline.

This perhaps did not start during the September quarter but can start in the coming quarters when the impact of a recession will be more vivid.

During TCS' Q2FY23 earning call on October 14, the CEO and MD of the IT bellwether - Rajesh Gopinathan - said that despite news flow around a possible economic slowdown across the world and client concerns over how that might affect their businesses, TCS hasn't seen any change in their spending on it so far.

"As you could see from the growth figures, demand for our services continues to be strong in Q2 across all verticals and all markets even in Continental Europe and UK, where the pessimism levels are at the highest," said Gopinathan.

But Gopinathan conceded that it could not be said that the deteriorating macro had no impact at all. He pointed out that clients had become more cautious when committing to longer-term investments.

"Some of the larger transformation programs are seeing prioritization of projects that offer quicker wins versus those with longer-term paybacks. Many of our clients are also working on plans for various economic scenarios for next year. We have also seen some sporadic instances of delayed decision-making on new deals," said Gopinathan.

Experts remain positive

Experts see value emerging in the IT sector even as they accept that there are headwinds. What seems to be giving hope is the better Q2 earnings of top IT firms.

"An important takeaway from the IT results announced so far is that the segment is doing well and the management commentary is optimistic. After the sharp correction in IT stocks from their highs, there is value in the segment now," said V K Vijayakumar, Chief Investment Strategist at Geojit Financial Services.

Piyush Pandey, VP of Institutional Equity Research (IT and Telecom), YES SECURITIES, said: “Results were, broadly, as per expectation, with IT companies being able to maintain growth momentum. The pressure on operating margin has eased off as expected."

Pandey believes the long-term outlook remains intact led by the rapid adoption of cloud and data analytics across enterprises. However, he highlighted that in the near term, clients have become cautious due to evolving macroeconomic situations and this is leading to more time in decision-making for new deals and can result in a moderation in growth in the near term.

Manik Taneja, IT Services Research Analyst, JM Financial Institutional Securities highlighted that Q2FY23 performance was decent and did not show any negative surprises. The Street feared for the worst in terms of near-term outlook going into the second half of FY23. The fear through larger sections was that companies may warn of significant moderation in Q3 and Q4 but that has not come through.

However, he underscored that the management commentary remains quite measured with companies saying that while they are watchful of the macro impact on client spending in the calendar year 2023, it still sees clients shifting their spending priorities towards cost optimisation. Taneja believes this will play to the advantage of Indian IT as they specialise in being the lowest-cost service provider for global businesses.

"We reckon that the upcoming earnings from global peers in November will provide a greater sense of near-term performance. We continue to believe that Indian IT, in general, remains more resilient to macro concerns and tends to hold up much better in case of recessionary fears as has played in the past cycles," said Taneja.

Apurva Prasad, Institutional Analyst - IT, HDFC Securities is optimistic about the IT sector.

"Strong revenue performance in the context of current macro and healthy deal bookings provides near-term growth visibility for the sector. We also reckon that margins have bottomed and are headed higher. We have a constructive stance on the IT sector and our preferred picks are Infosys from tier-1 IT and Persistent from mid-tier," said Prasad.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.

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First Published: 20 Oct 2022, 08:07 AM IST