JP Morgan downgrades Indian IT services sector to underweight

Global brokerage firm JP Morgan has downgraded Indian IT services sector to 'underweight' and cut the target price of multiples by 10-20 percent.

The brokerage firm says the Indian IT growth was accelerating till the third quarter of 2022 and has begun to slow down from the fourth quarter, which is likely to worsen into FY23 from tougher comps, supply issues and eventually a worsening macro. With peak sector growth behind, growth deceleration should continue to weigh on sector multiples.

"Rising margin headwinds in the near term and revenue headwinds in the medium term from a potential macro slowdown will mean that the sector’s earnings upgrade cycle is behind," JP Morgan said in its report.

"We see peak revenue growth behind us and EBIT margins trending down from inflation, mean reversion. While the bottom-up outlook remains positive from most Services, Software and SaaS names YTD, and the tech spending cycle remains buoyant structurally, we feel there are more downside risks to current earnings assumptions," the brokerage firm said.

The Nifty IT Index have underperformed the NIFTY by 15 percent so far this year as the earnings outlook has worsened over the current earnings season.

The brokerage firm has downgraded Tata Consultancy Services, HCL Technology, Wipro and L&T Technology to underweight from neutral and cut its target price by 15-21 percent.

"Indian tech services are the most expensive services names globally at a premium to digital native peers and Accenture, and at par with enterprise software that appears unsustainable. Sector reverse DCFs suggest that the market is still baking in 6-13 percent growth for Tier 1s and 14-33% for midcaps over the next decade; that seems optimistic given this remains a late cyclical sector for most names," the JP Morgan report said.

JP Morgan has an 'overweight' call on Infosys thanks to growth, Tech Mahindra for 5G cycle and margin expansion, Mphasis and Persistent System due to more defensive industry exposure and stronger growth outlook.