Tata Elxsi vs L&T Tech Services: Which is the better midcap IT stock?

Tata Elxsi and L&T Tech Services (LTTS) are two major midcap information technology (IT) firms that have been competitors for a long time. But which of these two firms is a better IT stock, let's find out:

Stock price

Recently, Tata Elxsi has outperformed LTTS, rising 80 percent in the last 1 year. In comparison, LTTS has fallen nearly 18 percent similar to the majority of its peers. Benchmark Nifty IT has also lost around 19 percent in the last 1 year.

Indian IT stocks have suffered in recent months, with the Nifty IT index ranking as the worst-performing index among all NSE indices so far in 2022, owing to recession fears, downgrades from global brokerage firms, an FPI selloff, and a rate hike in major economies. Tata Elxsi seems to be an exception.

In 2022 YTD, Tata Elxsi has surged nearly 50 percent as against a 35 percent fall in LTTS. In the last 5 years as well, Tata Elsxi has surged 971 percent versus a 353 percent rise in LTTS.

About the firms

Tata Elxsi Limited is a provider of design and technology services company. The Company operates in two segments: system integration & support and software development & services.

Meanwhile, LTTS provides services and solutions in the areas of product software, mechanical and manufacturing engineering, embedded systems, engineering analytics and plant engineering. The Company operates through five segments: Transportation, Telecom & Hi Tech, Industrial Products, Plant Engineering and Medical Devices.

Earnings

In the June quarter, LTTS' net profit rose 27 percent to ₹274.20 crore beating analyst estimates fuelled by healthy revenue growth in top clients and a demand uptick in its transportation vertical. In the corresponding quarter last year, the company posted a net profit of ₹216 crore. Meanwhile, its revenue grew 23 percent on year to ₹1,873 crore in the quarter under review against ₹1,518 crore in the corresponding period of the preceding fiscal.

Amit Chadha, CEO & managing director of L&T Technology Services, said, We started the new fiscal on a strong note with revenue growing sequentially by 4.7 percent in constant currency. Growth was led by Plant Engineering and Industrial Products, benefitting from spends towards digital manufacturing, energy transition and smart & connected products. Our big bets focus has helped us to align ourselves with these strategic and multiyear customer programs.

“I don't see a problem going forward for the next 2-3 quarters. We are not ringing warning bells already and we are reconfirming our guidance" added Chanda.

On the other hand, Tata Elxsi's net profit rose by 62.9 percent YoY in the quarter ended June 2022 to ₹184.72 crore. Last year, the company's profit was ₹113.37 crore. Its total revenue from operations stood at ₹725.9 crore for Q1FY23 as compared to ₹558.31 crore in Q1 FY22, an increase of 30 percent year-on-year (YoY).

Manoj Raghavan, CEO and Managing Director, said, “We are starting FY23 on a strong note with 6.5 percent QoQ revenue growth in constant currency. This was all volume-led and supported by robust growth across divisions, verticals, and key markets. We continue to maintain and expand our margins with our EBITDA growing at 58.8 percent YoY and PAT growing at 62.9 percent YoY."

However, over the last 5 years, LTTS revenue has grown at a CAGR of 10.9 percent whereas Tata Elxsi's revenue has grown at a CAGR of 8.1 percent during the same period.

Which one do analysts pick?

Among these two stocks, Omkar Tanksale, Senior Research Analyst, Axis Securities prefers LTTS. Here's why:

1) LTTS has a strong presence in the different verticals and

a higher geographical presence. This reduces the dependency on one particular sector, making the business more robust and having better sustainability. The strong client relationship indicates the robustness of the business.

2) LTTS has strong patents and strong digital capabilities to capitalize on the demand as compared to peers across geographies

3) Large deals in the pipeline also provide better visibility

However, Sunil Damania, Chief Investment Officer, MarketsMojo has picked Tata Elxsi.

"Tata Elxsi is part of our Mojo Stocks list, and we believe the stock should do very well. Between L&T Tech and Tata Elxsi, the latter is a better stock pick. We had recommended Tata Elxsi as a buy on 1st November 2021 at ₹5985. And we continue to believe that the stock still holds a lot of headroom for capital appreciation," Damania revealed.

Vinit Bolinjkar, Head of Research, Ventura Securities also prefers Tata Elxsi between the two midcap IT firms. We like Tata Elxsi over LTTS given its large addressable market, better margins and superior track record, he said.

Outlook on the IT sector

The June quarter has not been a very impressive quarter for the IT sector. Going ahead, Omkar Tanksale of Axis Securities believes that as businesses continue to rely on technology, both for driving incremental revenue and optimizing costs, the demand for Indian IT Services would remain buoyant despite an uncertain macro environment.

"Migration and Digital transformation initiatives will continue to drive significant demand for Indian IT companies. Improved pricing, increased off-shoring, greater fresher addition, lower attrition, and decreased reliance on subcontractor expenses will help companies maintain margins. Macro concerns have already been factored in the recent correction in the IT Services space. We remain positive on account of sustained long-term demand. We continue to like Infosys and Tech Mahindra in Tier-I, and Mindtree and Persistent Systems among Tier II players," said Tanksale.

Meanwhile, Damania of MarketsMojo also believes the midcap IT sector is likely to face a few challenges. The sector's outlook for FY2023 will depend on the commentary emerging from IT companies' post-September numbers, he said.

"We opine that the attrition rate has started to decline, but further clarity will emerge once the results are out. We will also get clarity as regards what kind of cost increase IT companies could pass on to their customers. The September 2022 quarter could be challenging for the industry," noted Damania.

He further pointed out that Nasdaq outcomes also impact Indian IT companies. For instance, in 2022, Nasdaq and Nifty TI moved in tandem. Hence, until the sentiments on Nasdaq do not improve, Indian IT companies will likely continue to suffer. We believe that while the long-term outlook looks promising, there could be short-term challenges. Therefore, one would need to revisit the IT sector post-September numbers, suggested Damania.

Bolinjkar of Ventura noted that in terms of the outlook for the sector, we believe that in spite of the recession, most of the IT companies have reported good deal wins in Q1 and the commentary has also been cautiously optimistic. The attrition rates have peaked out and should slowly start normalizing from hereon, he added. Further, deal wins continue to be robust as most companies now consider IT as operational costs rather than capex and one can slowly start entering the sector with a 2-3 year horizon to earn decent returns, advised the expert.