Indian IT stocks have witnessed a drastic fall this year, dragged by concerns over a recession in the US and Europe which are the major markets for IT firms.
After the US Federal Reserve said that the fight against inflation is not over yet and rate hikes would continue in the next year, the concerns over a recession have grown stronger.
If the US sees a recession, there will be a significant impact on the IT companies' demand scenario, which will dent their profitability.
Analysts and brokerage firms point out that the demand for digital and cloud services has started to cool off.
A couple of days ago, global IT firm Accenture reported lower deal bookings for this quarter, highlighting the impact of a deteriorating macro.
The Nifty IT index is down 26 percent this year as of December 20 close, with all stocks in the red. Stocks such as Wipro, Mphasis, Tech Mahindra and LTIMindtree have fallen more than 40 percent each. Equity benchmark Nifty50 is up 6 percent for this period.
IT could be a contra bet
The near-term outlook for the IT forms looks bleak but they can be decent value bets for the long term as their valuations have decreased significantly.
Most negatives for the IT sector are already on the table which is expected to limit the further downside in the IT stocks.
Besides, the recession in the US will be a temporary phenomenon and not a structural issue, so the pain for the IT sector may not last long.
Analysts advise accumulating IT stocks on dips for a long-term timeframe.
Seshadri Sen, Head of Research, Alchemy Capital Management believes the FY24 earnings of IT firms may be a mixed bag - revenue growth is likely to slow, but margins could rebound as wage cost pressures ease.
However, Sen pointed out that the revenue slowdown is temporary as the long-term runway of tech, and digital spending by global corporates remains robust.
Sen sees the IT sector as a long-term contrarian bet despite the near-term headwinds.
"In our view, the correction makes IT a contrarian opportunity, given the high-quality and ultra-profitable companies in the sector. The valuations, however, are still hovering around long-term averages, so it may not be an instant-gratification trade but is likely to be an outperformer from a one-two-year perspective," said Sen.
G Chokkalingam, Founder & Head of Research at Equinomics Research & Advisory also consider IT as a contrarian bet as he expects the rate hike cycle to end by the middle of the next year which will improve the prospects of IT stocks.
"Yes, the IT sector could be a contra bet with an investment horizon of the next one year. By the middle of 2023, the rate hike cycle must be over and the same would help US IT stocks to gain substantially. Peak out in interest rates would end the dollar rally which would improve the profitability of the US IT stocks," Chokkalingam explained.
"As the valuations of US technology stocks and domestic IT stocks are positively correlated, after mid-2023, Indian IT stocks are likely to do very well. Also, the overall market sentiments here are likely to take a hit from the second half of 2023 on account of the next General Elections in India and a possible rally in crude oil prices. Global demand for oil is likely to pick up significantly from mid-2023 as global economic growth is expected to improve. These two possible scenarios are likely to force investors to tilt towards IT stocks. Hence, IT stocks could be a good contra bet now with an investment horizon of one year," said Chokkalingam.
A steep fall in the rupee exchange rate will also help this sector to bargain better and pass on employee cost hikes to some extent in the medium term.
"Better option could be focusing on beaten down quality small and midcap IT stocks as the sector’s growth in dollar term is in poor single digits. It is possible for further consolidation in this sector through acquisition is very much possible," said Chokkalingam.
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.