Indian IT services industry is facing near-term challenges due to the economic slowdown and weaker macroeconomic outlook. However, its long-term outlook remains robust with the economy showing signs of recovery. In a recent report, brokerage house Axis Securities said that it believes that the recovery in IT space will begin in the second half of the year and FY24 will show strong revenue growth. The brokerage has listed the key hits and misses for the IT space from the June quarter earnings.
HITS during the quarter
- Despite the delay in automation spending, deal wins remained strong this quarter. Many of India's IT services companies reported the highest order books despite the lack of near-term visibility.
- The attrition rate has dropped as we see some easing on the supply side. This would help IT companies improve their operating margins.
- Subcontractor costs are likely to weaken as demand weakens, which should have a positive impact on operating margins.
- Broad-based growth was led by manufacturing and retail segments.
MISSES during the quarter
- Growth visibility is likely to remain under pressure as the slowdown negatively impacts overall business activity.
- Delayed decisions have weakened revenue growth momentum, even if the deal wins remain resilient.
- Higher onsite expenses and rising costs have negatively impacted operating margins.
- Lack of visibility caused IT services providers to slow down the hiring process, which impacted future revenue growth momentum.
After strong revenue growth momentum in FY22 and FY23, Axis Securities believes that the IT services industry may face challenges on the demand front and margins fueled by the economic slowdown and macroeconomic uncertainties. It has a skeptical near-term outlook for North America (40 percent of revenue).
It further pointed out that the deal wins remained resilient even during the difficult times, which gives confidence that automation spending will rebound strongly in two to three quarters. Demand in industries such as retail and manufacturing remains strong and is expected to regain momentum in the near future. Also, the demand for newer technology services such as generative AI, machine learning, IoT, and cloud transformations remains stable and is likely to recover more quickly as certain macroeconomic challenges subside, noted the brokerage.
It continues to believe that most IT services companies will regain momentum in the second half of the year as deal wins remain resilient and supply-side challenges ease. Many of the companies that are becoming increasingly system-oriented and unable to escape the costs of automation should have strong long-term demand, added Axis Securities.
- Any positive news from North America will lead to a sharp recovery in the Indian IT sector.
- Easing banking crisis is expected to lead to higher confidence in automation spend and is likely to lead to a strong recovery in the BFSI vertical.
Top sector ideas: IT services
Amid this backdrop, the brokerage has listed its top 3 ideas from the IT services space - Coforge, Persistent Systems, and IndiaMart Intermesh.
Coforge: The brokerage has a ‘buy’ call on the stock with a target price of ₹5,900, indicating an upside of 20 percent.
“We are encouraged by the improved outlook in the vertical and engagement with clients give us confidence in the company’s future prospects. TCV was strong in Q1FY24, with robust quarter-high deal wins at $531 Mn each in BFSI and Travel verticals. The US is seeing higher cost optimization deals (with faster decision-making), while the European market remains impacted. As the macroeconomic environment stabilizes, the company expects decision-making to pick up. Given the company’s strong growth potential, supported by solid deal-making and excellent execution capabilities, we recommend BUY on the stock,” explained the brokerage.
Persistent Systems: The brokerage has a ‘buy’ call on the stock with a target price of ₹5,570, implying a 15 percent upside.
"The continued strength of the demand environment in the medium term: The UK is seeing higher cost optimization deals (with faster decision making), while the European market continues to be impacted. As the macroeconomic environment stabilizes, the company expects decision-making to pick up. We believe Persistent is well positioned for encouraging growth given its numerous long-term contracts with the world’s leading brands. Improved revenue visibility gives us confidence in the company's continued growth," it explained.
IndiaMart Intermesh: The brokerage has a ‘buy’ call on the stock with a target price of ₹3,625, which implies an over 17 percent upside.
"Indiamart’s key strengths are i) Strong foothold in the B2B digital platform, ii) High growth opportunities for paid subscribers, iii) Robust platform comprising diverse product portfolio, v) 143 Mn registered users/buyers on the platform and traffic is 100 percent organic. Indiamart's conversion factor is higher than other Indian companies. With a higher value proposition for sellers, more and more will be willing to pay for listing services. If we assume a higher conversion factor for IndiaMart, paid sellers can reach 60 million (4x the current base)," said the brokerage.