From being the engine of a market rally last year, information technology stocks have turned the leaders of market correction this time.
The Nifty IT index entered the bear market territory as with an over-26 percent fall from a record high of 39,446.70 points hit earlier this year. On May 19, the selling pressure on IT stocks continued as the Nifty IT index nosedived nearly 4 percent with individual counters shedding 3-5 percent.
While the early part of the correction was driven by profit-booking by investors on account of high bond yields and shrinking margins, the recent leg of selling has been driven by fears of key geographical markets entering recession over the next few quarters.
In 2021, the Nifty IT index rallied 59 percent driven by strong earnings growth for IT companies that were bagging multi-million-dollar digital transformations deals in the US and Europe.
The relatively strong growth guidance given by IT companies for 2022-23 have now come under threat, given the apprehension of the US economy slipping into recession later this year.
US investment bank Goldman Sachs recently warned that there was a 30 percent chance the US economy will tip into recession over the next two years because of aggressive interest rate hikes by the US Federal Reserve. Others such as Well Fargo and Morgan Stanley believe a recession in the US is around the corner as the Fed shows no signs of easing its fight against multi-decade high inflation.
The US market contributes 40-78 percent of revenues for Indian IT companies with the big five – Tata Consultancy Services, Infosys, Wipro, HCL Technologies, and Tech Mahindra – having more than 50 percent exposure.
Besides the US, the European market is also feared to be heading into a recession as the Ukraine-Russia war, soaring energy prices and prospects of higher interest rates push the EU on the brink of a recession over the next two years.
US Treasury Secretary Janet Yellen on May 18 claimed that while she sees no recession in the US, Europe is “more vulnerable” to falling into a recession due to the fallout of the sanctions on Russia following its invasion of Ukraine.
“What is priced into stock is risk to margins. What is not priced in is economic recession,” Kotak Equities said. The brokerage firm has trimmed its fair value targets for nine IT stocks under its coverage by 2-14 percent assuming a moderate slowdown in demand for IT services.
NO PAIN?
Infosys in its conference call with analysts following its March quarter earnings in April suggested that the macroeconomic uncertainties such as the Ukraine-Russia war and high inflation have not had any impact on the demand environment.
“As we look at our demand environment we do not see any impact to it. We do not see really an impact of those factors in the demand environment today,” Infosys Chief Executive Officer Salil Parekh had said.
Even Wipro, whose 1-3 percent sequential sales growth guidance for June quarter disappointed investors, expressed the same sentiment as Infosys in that the demand situation remains strong.
“Based on what we are seeing today, looking at the pipeline or talking to our clients, no signs of slowdown either. So we stay close to it, we talk constantly to our clients, but today, no real sign of slowdown,” said Wipro CEO Thierry Delaporte.
IT companies have maintained that pipeline for digital transformation deals, the main driver of order book since the onset of the pandemic, will remain strong for many years to come driven by structural need for companies to shift operations to digital.
Brokerage firm IIFL Securities in a recent conversation with Infosys management noted that there is a long runway for cloud deals, shifting from infrastructure-as-a-service to software-as-a-service. “Their target market would be $800 billion plus of internal IT spending, managed by the customers themselves,” IIFL Securities said.
BARGAINS?
Kotak Equities believes that prices of IT stocks have become attractive even assuming a moderate demand slowdown going ahead.
Price-to-earnings multiples of Indian IT companies have compressed from 33-35 times one-year forward earnings to around 24-27 times over the course of the year due to the ongoing correction in the sector.
However, any rebound in sentiment for the sector may entail some more pain as investors start factoring in the rising likelihood of slower revenue growth in the coming quarters.
“A slowdown in economic growth can lead to trimming down of tech spending. Overall tech spending growth will come down from current expectations but can remain reasonable,” Kotak Equities said.Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
