Analyst Tracker: IT stocks see surge in rating upgrades; four factors driving optimism in IT sector

The deal pipeline remained robust across the IT industry in Q4 FY24.

IT companies within the Nifty 50 index -- Tech Mahindra, LTIMindtree, HCL Tech, and TCS -- dominated the list of stocks that saw a surge in rating upgrades by brokerages over the last three months (March-May). Despite continuing to face challenges such as muted demand and weak discretionary spending, analysts believe that IT stocks have potentially bottomed out, reaching a favourable buying position.

Tech Mahindra witnessed the most substantial increase in upgrades, with 'Buy' calls rising from 13 to 22 in the previous quarter. TCS followed suit with a notable increase of 4 'Buy' calls, reaching a total of 29, the highest among its peers. Similarly, LTIMindtree and HCL Tech each received 3 additional 'Buy' calls, bringing their tally to 16 and 21, respectively.

According to the IT sector's Q4 FY24 financial results, BFSI, retail, hi-tech, and communication verticals showed persistent weakness, while manufacturing, energy, and utilities fared relatively better. The FY25 revenue guidance also fell short of expectations, indicating a slower recovery path towards normalisation. However, the earnings were on expected lines, with no unusual surprises, said experts.

On the upside, margins improved in Q4 FY24 for most companies (except HCL Tech and LTIMindtree) due to higher utilisation, an offshore shift, and reduced discretionary expenses.

Market experts are bullish on IT stocks, citing several reasons for their optimism. These factors highlight a potential resurgence in the sector and its attractiveness to investors.

Comfortable valuations

Market experts believe that IT stocks have bottomed out and are now at attractive valuations.

Emkay Global noted that the correction in IT stock prices over the last few months has made valuations more reasonable. "We prefer large caps over mid-caps, considering relative valuation," the brokerage said, adding that its top picks in large caps include Infosys, HCL Tech, Wipro, Tech Mahindra, TCS, and LTIMindtree.

"IT counters have not performed in the last 1.5-2 years. I think it is time for them to lead the rally from here," said Kunal Rambhia, Fund Manager & Trading Strategist at The Streets.

Per technical indicators, the BSE IT index had a very strong support zone at 33,300, from where the buying is expected to continue until 36,000-36,500. On Friday, 7 June, the IT index jumped 3.4 percent to end at 35,909. After delivering negative monthly returns from March to May, the index has gained over 8 percent in June.

Strong deal pipeline

The deal pipeline remained robust across the IT industry in Q4 FY24. Total Contract Value (TCV) growth was strong, despite a slight moderation due to fewer mega deals signed by Tier-1 players. Infosys and TCS reported strong bookings, bolstered by large and mega deals, while Wipro and Tech Mahindra experienced muted TCV.

"A positive aspect reported was that deal sizes and wins were on a good, comfortable trajectory, providing visibility for the next year," said Rishubh Vasa, Research Analyst at Indsec Securities & Finance.

Political uncertainty shifts investment focus to IT

With the Indian general election results not coming in as expected, it has led to concerns that the new government could struggle to accomplish its goals without a full majority. This has put pressure on infrastructure spending and government investments. As a result, funds would now flow into the IT sector.

US interest rate cut speculations: A potential boon

Growing hope of a rate cut by the US Federal Reserve has triggered a fall in US bond yields, positively impacting IT stocks. Lower bond yields generally create a favourable environment for IT stocks due to reduced borrowing costs and shifts in investor preferences toward growth-oriented investments.

Interest rate cuts will ease client pressure and boost spending, benefiting the IT sector, said Vasa. However, these cuts will take time and likely begin after the US general elections clarify the political landscape.

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