India IT Services Demand Tracker- June To Be Soft, But Overall Long-Term Demand Is Resilient: ICICI Securities

ICICI Securities Report

Nifty IT is currently trading at 21 times one-year forward earnings per share versus last 15-year average of 18 times, a 16% premium over Nifty 50 price/earning of 18.5 times (in line with historical average premium of 16%). However, one-year forward EPS growth of Nifty IT at 7% is lower compared to Nifty 50 EPS growth of 12%.

Valuations for Indian IT sector are still not attractive and there is scope for further downside due to weak earnings growth in the next one-two quarters, but we believe multiples could sustain in the medium term given strong structural demand tailwinds around cloud migration and digitalisation.

We assume pick-up in growth in H2 FY24 and assign last five-year average multiple to companies in our coverage universe, which was the beginning of cloud and digitalisation cycle for Indian IT companies.

In the existing scenario, we continue to believe stock price returns may be driven by earnings growth rather than multiple expansion.

We maintain 'Buy' on Infosys Ltd., Persistent Systems Ltd. and Tata Consultancy Services Ltd., upgrade HCL Technologies Ltd. to 'Add' (earlier: Hold), maintain 'Add' on Mphasis Ltd., downgrade LTIMindtree and Happiest Minds Technologies Ltd. to 'Add' (earlier: 'Buy'), maintain 'Reduce' on Wipro Ltd. and downgrade Tech Mahindra Ltd. to 'Sell' (earlier: Reduce).

Our downgrades are due to run-up in stock prices in the last two months with no change in our underlying thesis, our estimates and target prices. There is a risk of our and consensus Q1 FY24 and FY24 estimates to be revised downwards.

Our top picks are Infosys, Persistent Systems and TCS and bottom pick is Tech Mahindra.

Downside risks:

• Any potential negative impact of Generative AI on contract pricing and margins, which is still unknown,

• delayed macro recovery and tech spending outlook due to persistent high inflation and interest rates,

• pricing pressure and margin dilution due to higher focus on cost optimisation deals where competition is stiff.

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