Even though Nifty IT has fallen nearly 5% in the past week, and nearly 9% over six months, Global financial services firm Macquarie is positive on Indian IT firms and believes accelerating digital transformation will create a multi-year demand for the IT services providers.
Macquarie underscored a generational shift in consumer behaviour has happened in the past 24 months, and firms are accelerating their digital efforts to survive.
"We see digital transformation as the biggest enterprise technology shift since the adoption of web technologies and ERP (enterprise resource planning) and expect it to take years and for demand to remain strong at least till FY25," said Macquarie.
Enterprise resource planning (ERP) is a type of software that companies use to manage day-to-day business activities such as HR services, finance, accounting, project management, supply chain operations, etc.
"FY22 growth rates are elevated for most firms due to the base effect of Covid-impacted quarters in FY21. But incremental revenue is up nearly 3 times in Q3FY22 vs pre-Covid and is largely sustainable, per our HAMM framework indicating a cyclical upturn. Our Asia technology team estimates nearly 15 percent CAGR the next three years for Datacentre/Hyperscalers and nearly 30 percent for AI, accelerators and Edge Compute, suggesting strong demand drivers medium-term," said Macquarie.
The brokerage firm pointed out that while "valuations for almost all firms are two standard deviations above the TTM PE mean of the last five years, this is well justified, as the industry is in a very different place."
Concerns regarding the ability of Indian firms to participate in digital transformation have been put to rest as firms started reporting digital revenues and contracts, such as TCS’s deal with Marks & Spencer for supporting its digital transformation or HCL Tech’s deal with Manchester United to give fans a digital experience, the brokerage firm observed.
The US is struggling to fill job openings across the economy, and with work from home being the norm, visa issues are no longer an overhang on the sector. These were factors that weighed on valuations over a large part of the last five years, said the brokerage firm.
"All these factors and earnings surprises depressed multiples. We are convinced of a structural uptick, and our revenue estimates are materially above the consensus which seems to view FY22 as just pent-up demand. Our pecking order for investors with a three-year horizon is HCL Tech->TCS->Infosys->Wipro->Tech Mahindra," said Macquarie.
Given the paucity of supply and the strength of the demand environment, Macquarie believes any benefits of rupee depreciation are likely to be largely retained by system integrators, with some flowing into the margin and some of it being used to improve wages and improve talent retention.
Disclaimer: This article is based on a Macquarie report which is available on public platforms. Views and recommendations made above are those of the broking firm and not of MintGenie.