IT Stocks Outlook: Citi Cautious Despite Rupee Depreciation Amid Global Macro Uncertainty

Citi Research is cautious on India's IT stocks despite sharp correction as it believes global macro uncertainty is looming over their multiples. Multiple helps to determine a company's valuation, and other factors of financial performance. The brokerage has lowered revenue estimates for most companies in the space.

The NSE Nifty IT underperformed by 12% compared to the benchmark NSE Nifty 50 index despite substantial depreciation in the rupee, the brokerage said. Compared to Nifty 50, Nifty IT trades at 30% premium.

The expectation of the US growth in Donald Trump's second term as president in the October–December quarter did not materialise. After Trump took office, rather more uncertainty is rising over US economic growth with his protectionist policies.

Indian IT companies have a significant exposure to the US markets. Hence, any adverse change in the US ends up hurting Indian IT companies' performance. Moreover, global peer companies like Epam Systems Inc. and Globant have given disappointing guidance in this backdrop, Citi Research said in the note.

Citi Research believes that margin improvement in a high competitive scenario is not easy despite INR depreciation for top five IT companies. The brokerage sees that margin will likely remain flat. However, earnings per share estimates are favourable due to the rupee depreciation.

Valuation of Indian IT companies remains high since the pandemic, unlike lower growth. In the medium term, IT companies will face challenges because of artificial intelligence disruption and software growth impacting spending. Free cash flow yield for India's top IT company is at 3.5–4%, which is unattractive compared with the near-term outlook, Citi Research said.

Citi Research upgraded Mphasis Ltd. to 'Neutral' rating from 'Sell' after its steep correction in the stock and improved growth outlook. However, near-term growth will be challenged because of the condition of the industry.