IT Sector To Grow As Demand Climate Improves Gradually, Say Analysts

Nifty IT has risen by 5.3% since the announcement of the election results on June 4. However, over the past year, the sector has underperformed the Nifty 50 by 4.1 percentage points.

NDTV Profit examined the sector from three perspectives: growth visibility for fiscal 2025; room for upside in margins; and valuation of IT stocks.

IT companies' revenue growth guidance indicates a lack of green shoots for fiscal 2025.

Infosys Ltd. projected a soft constant currency revenue growth of 1–3% for fiscal 2025. While HCL Technologies Ltd. had given growth guidance of 3–5% for the same year, Coforge Ltd. suspended guidance due to a lack of visibility, despite having the highest-ever order intake.

Global peers have also provided guidance in the low single-digit range for fiscal 2025. Accenture revised its revenue growth guidance to 1–3% from the previous level of 2–5% for the financial year 2024–2025. Capgemini guided for 0–3%, while Cognizant has guided for -2 to 2%.

But while the order book pipeline remains strong for most of the IT companies, is that sufficient for betting on the IT stocks?

Clients taking a pause on contracts and even cancelling deals can be the cause of weaker guidance. For example, revenue for Infosys missed estimates largely due to contract re-negotiation and a reduction in scope in a deal in the BFSI vertical. In the fourth quarter of fiscal 2024, LTIMindtree Ltd. experienced two deal cancellations in the BFSI space.

Jefferies is expecting the highest margin improvement for Tech Mahindra Ltd.

Possible levers include reduced subcontracting costs, improved utilisation, and optimisation of the employee pyramid. Utilisation levels for the IT companies are nearing their peak and have limited scope for further improvement, Jefferies said in a note.

IT firms have been cutting down on subcontracting costs for a while now and have been at their lowest since fiscal 2015, and there is limited scope for further reduction. Other overhead costs from increased office work could also put pressure on margin expansions.

"Among firms, HCLT and Wipro have the lowest potential to boost margins from overhead, given that their overheads are at a five-year low," Jefferies said.

Nifty IT is trading at a 33% premium to Nifty 50, based on fiscal 2025 price-to-earnings. Among the top six companies, Tech Mahindra, Wipro, and HCL Technologies are trading more than their five-year average PE ratio, while others are just near. 

Jefferies sees risks of earnings per share cuts for the sector, which, along with rich valuations—both in terms of absolute and relative to Nifty—limit upside. Infosys remains its top pick.

"Currently, we believe markets are disproportionately valuing growth over cash conversion. We believe the demand environment is likely to improve only gradually at best, and hence this valuation trend is likely to sustain itself in the near term," said Yogesh Agarwal, head of research, India at HSBC Securities.