After weak March quarter numbers, global brokerage house JP Morgan retained its negative stance on the IT sector. The brokerage downgraded the sector to underweight from Neutral earlier on the back of an overall weak demand environment.
JPMorgan rules out a V-shaped recovery for IT sector; places Infosys, TCS, Mphasis on negative catalyst watch
While JPMorgan is negative for the entire IT services universe, it has placed Infosys, TCS and Mphasis on negative catalyst watch, and also downgraded Persistent Systems to ‘underweight’.
The brokerage has maintained its 'underweight' call on Infosys, TCS, and Wipro as well as Mphasis. Moreover, the brokerage downgraded Persistent Systems to underweight from neutral and cut the target to ₹4,100 from ₹4,200 earlier.
The brokerage also expects IT firms to disappoint in the June quarter (Q1FY24) as well as in the second half of FY24.
JPMorgan estimates FY24 industry growth to be below 5 percent year-on-year (YoY), ruling out a quick or V-shaped recovery.
"We feel current expectations of a quick or a V-shaped recovery are likely to prove optimistic and could be unlikely over the next 6-9 months, suggesting all of CY23/FY24 could be a washout as opposed to just 1HCY23 as currently perceived," it said.
It further added that it sees most IT services firms missing current expectations and trimmed its Street-low estimates by 1-3 percent to bake in Q1 weakness and doesn’t anticipate any second-half recovery.
“We believe paused projects may have limited visibility of restarting and signs of demand recovery over the next 6-9 months could be low, potentially driving growth expectations in the second half lower, and FY24 industry growth to sub 5 percent YOY levels (from our previous 4-7 percent post 4Q results),” the note said.
Meanwhile, the brokerage also sees demand worsening in June. It also noted that deferred project starts, project halts and cancellations are likely to persist and it believes that increased competition for a smaller pie could trigger falling win rates, pricing and deteriorating deal terms.
“India IT Services offers investors an opportunity for a short IT Services trade for the second time in six months. After meeting 15 industry participants in Bangalore, we came away feeling that the demand environment for IT Services has likely weakened further in June,” the report said.
It further stated that paused projects may have limited visibility of restarting and signs of demand recovery over the next 6-9 months could be low, potentially driving H2 growth expectations lower and FY24 industry growth.
According to JPMorgan, a miss in Q1 earnings can drive a 2-3 percent earnings cuts for TCS and a 3-4 percent earnings cuts for Infosys and Mphasis in Q1FY24.
On TCS, the brokerage said, “We remain UW (underweight) on the stock as we bake in lower growth from macro concerns in FY24E that will also limit significant margin expansion. Moreover, the unexpected CEO departure could lead to periods of volatility in a time of weaker tech spend and rapidly evolving macro.” It has set a price target at ₹2,700 for March 2024, indicating a 17 percent downside.
The brokerage also cut estimates for revenue and earnings by 1-2 percent over FY24-26 for Infosys. It is underweight on the stock with a target of ₹1,170 by March 2024, indicating a downside of 10 percent
“Our UW thesis (for Infosys) is driven by three main factors: Lower growth expectations in FY24 of around 3 percent CC YY, below the lower end of the company’s guide of 4-7 percent, as we believe H1 will be weak, given the uncertain macro, and 2H won’t be able to carry the burden of lifting full-year growth, weak leading indicators in the forms of declining net new large deal TCV and a sharp slowdown in hiring, suggesting weaker growth ahead, and Infosys’s loss of growth leadership to TCS in Q4FY23 while slipping margins are not yielding a growth advantage,” it explained.
For Mphasis, the brokerage sees growth challenges in the BFSI vertical and limited scope for margin expansion. It has a target of ₹1,550, indicating a downside of over 17 percent.
Meanwhile, the brokerage finds Persistent Systems expensive given slowing growth in a tough macro environment. It downgraded the stock to underweight ad cut its target to ₹4,100, indicating a downside of over 17 percent.
And for Wipro, JPMorgan noted that the weak June quarter guidance highlights the challenging macro environment that will lead to a sharp slowdown in growth in FY24E and keep it under pressure in the absence of operating leverage. Wipro’s higher consulting exposure keeps it at a higher risk of a slowdown than peers, it said. It has maintained an underweight rating with a March 2024 price target of ₹360, indicating a downside of 9 percent.
For HCL Tech and Tech Mahindra, the brokerage sees downsides of nearly 21 percent and 12 percent, respectively, despite the rise in target prices.
Stock price trend
Nifty IT has risen only 3 percent in the last 1 year as against a 19 percent rise in benchmark Nifty. Meanwhile, it is completely flat in 2023 YTD, up just 0.2 percent versus a 3.5 percent jump in Nifty.
Four of the 10 constituents in the Nifty IT index are in red this year so far. Infosys has lost the most, nearly 15 percent followed by Mphasis, down around 5 percent. Meanwhile, Wipro and TCS fell around 1 percent each.
On the other hand, Persistent Systems was the top performer in the index, rising 20 percent followed by Coforge, up 18 percent and LTIMindtree, up 13 percent.
HCL Tech, Tech Mahindra, and L&T Tech rose between 4-10 percent each.
Meanwhile, in the last 1 year as well, Persistent Systems was the top gainer, surging almost 54 percent. Mphasis, on the other hand, is the top loser, down over 18 percent in the last 1 year. Wipro and Infosys also shed over 7 percent each, whereas TCS rose 2.6 percent in this time. HCL Tech and Tech Mahindra, however, were up 18 percent and 14 percent, respectively.