Infosys To Coforge: These Are Morgan Stanley's IT Picks As It Sees Cyclical Recovery

A gradual cyclical recovery for revenue of Indian IT companies is underway, according to Morgan Stanley, but it recommends staying selective on stocks. The brokerage prefers Infosys Ltd. and Coforge Ltd. as it sees room for near-term guidance upgrade, along with LTIMindtree Ltd., on which, analysts are divided but the brokerage has a constructive view.

"We expect growth rates to improve in 2025 (FY26) and the cost environment to remain benign (improving margin outlook), leading to double-digit EBIT growth," Morgan Stanley said.

The brokerage's US economics team recently lowered the country's GDP growth forecasts and now expects a lower quantum of rate cuts in 2025 than previously pegged. "We maintain our view of a cyclical recovery in revenue growth supported by the profit pool of large US/European banks expanding over the next two years," it said.

At the same time, it noted investor positioning is already favourable, relative valuations are becoming expensive, and upside to recovery in BFSI is offset by weakness in other verticals such as manufacturing

Another negative argument, according to the brokerage, is around potential impact of Gen AI on IT Services as recent election outcome in US has left the Street even more divided.

The bulls are comparing the current setup in 2025 to that of 2018, when the sector saw a sharp outperformance after the benchmark had underperformed in 2015-17—led by both cyclical factors as well as a change in the technology cycle, creating a transition period of moderate growth.

However, it said that the setup doesn’t appear to be similar to 2018 as underperformance in 2015-17 was stark, unlike 2023/2024 and the starting point of valuations was favourable in 2018, which is not the case currently.

It also noted that companies have yet to see a transition period of change in technology now, compared to 2018, when the transition period was largely behind. "Further, we note that investor positioning is also not as favourable as it was during the start of 2018, as both DII/FIIs are already quite OW the sector," it said.

Bears believe that global IT services companies' revenue downgrade cycle is not over and pointed to a mixed picture for 2025. "Commentary from India IT companies on small deals is mixed and the outlook on the return of discretionary spend on a broad-based basis is still not clear," it said.

The thesis of margin improvement in the sector in 2025 could be elusive if growth is backed by cost optimisation deals (competitive on pricing) and if cost inflation starts to increase (as attrition rates pick up), the brokerage pointed out. "With this background, there is a concern that EPS expectations could see some correction," it said. "Moreover, the sector has already outperformed in 2024 YTD vs Nifty 50 and valuation multiples are not cheap (trading at 5% premium to the last five-year average)."