Does Tata Sons' sale of TCS shares signal stress in IT sector?

Over the last one month, the Nifty IT index was down by more than 6 percent while Nifty 50 was down by 1 percent.

On March 19, Tata Consultancy Services (TCS) shares closed at Rs 3,971, down more than five percent from its 52-week high of Rs 4,254.75. This fall came after promoter Tata Sons offloaded a stake in the company. Tata Sons, the holding company of Tata Group, sold around 2.02 crore shares, or 0.6 percent equity, in TCS in a block deal worth Rs 9,000 crore. The average share price for the sale was Rs 4,043 per share.

What drove the sale?

In Q3, TCS reported a net profit of Rs 11,058 crore, up two percent year on year (YoY) from Rs 10,846 crore in the same period of the previous fiscal. Consolidated revenue for the reporting period also rose four percent YoY to Rs 60,583 crore in Q3FY24 from Rs 58,229 crore a year earlier. Analysts have mostly been positive on the company. As of March 19, out of 46 brokerages, more than 50 percent analysts (26) have a buy call on the stock while an equal number have a hold (10) and sell call (10).

The company has not disclosed the reason behind selling stake, although most believe that this could be driven by Tata Sons’ aim to reduce debt at a group level and avoid heading towards an initial public offering (IPO). However, the Reserve Bank of India (RBI) rules state that if a 'core investment company' has assets worth less than Rs 100 crore and does not raise public funds it can avoid being classified as a Credit Information Company (CIC) or an 'upper layer' NBFC and is not required to go for a public listing. Tata Sons was classified as an upper layer NBFC in 2022.

According to Purvesh Shelatkar, Head of Institutional Broking at Monarch Networth Capital, the sale could also possibly indicate that the management thinks the stock is fully valued or overvalued at this point. Additionally, it could also mean that the stress in the IT sector is likely to be reflected in the upcoming results season, he says.

Over the last one month, the Nifty IT index was down by more than six percent while the Nifty 50 was down by one percent.  The index has also been trading below 10 days SMA and 20 days SMA, signalling short-term bearishness. "The IT sector has done well in the last three-four months. It may be time to relook whether valuations will match expectations or not as otherwise TCS management would have opted for a buyback. Both the previous buybacks were higher than the current offloading of stake," Shelatkar adds. The last TCS buyback was in December 2023. At that time, Tata Sons and Tata Investment Corporation Ltd sold 25 lakh shares.

But not all hold the view that stress in the IT sector could be driving the sale. According to Wealthmills' Kranthi Bathini, Tata Sons holds a majority stake in TCS and is diluting a small percentage. " It's not a big dilution. The need for capital and liquidity for diversifying their business models and futuristic businesses is the primary reason why at this point of time they are diluting some stake," he says. One of the recent focus areas for the company has been expanding its capabilities in AI.

What is next for the IT sector?

In a recent report, CLSA analysts reiterated caution on IT stocks with sell calls for major IT names including TCS. According to the brokerage, there are downside risks to the revenue growth of stocks in the segment due to the weak macro environment. But not all are negative on the sector. In a recent report, analysts at Sharekhan said that they anticipate growth momentum to return in FY25, aided by a lower base coupled with easing sector headwinds. “Although the IT sector has already outperformed the Nifty last year, we expect overall outperformance in CY24 as well, driven by receding headwinds and better earnings visibility,” the report added.

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Post pandemic, Bathini says, the IT sector has been going through turbulent times due to the uncertainty on Fed rate cuts, and inflation concerns. "Overall, there is a lower hang with respect to the earnings of top, large cap IT companies which could remain for the next one or two quarters. But from a retail point of view, one can see these companies have quite robust and strong business models. So probably there might have been underperforming in a short-term perspective, but if you see the longer-term prospect of five to 10 years, IT always tends to be an outperformer,” he adds.

The overall negative sentiment that has been seen in the broader market could be behind the decline in IT stocks and not necessarily just due to stress in the segment. Shailesh Saraf, Founder, Value Stocks, explains that over the last one year foreign investors have been selling IT stocks so the IT sector has not been performing much and has already been under pressure.

“Even if you see the broader indices, they have also been under pressure. When the major indices are under pressure, we may be seeing short-term correction in most of the segments. The general market sentiment has also been bad. There has been short-term technical correction, but fundamentally there is no problem in the markets,” he said.

Talking about TCS, analysts at KR Choksey, in a report, said that given the size of the company, key deal wins, and focus on enhancing capabilities in key demand areas, they believe that TCS will be able to navigate the current macro-economic conditions.

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