Moneycontrol Pro Panorama | IT stocks get a harsh reality check

Demand in IT for this quarter so far has been subdued and spending caution is rising among clients.

Dear Reader,
Reality eventually catches up. Take, for instance, the case of IT stocks. Shares of IT services companies came under selling pressure in Tuesday trade after EPAM Systems, a software engineering services company, lowered its 2023 revenue guidance for the second time in five weeks.

The midpoint of the latest guidance implies a 2 percent reduction in full year revenues, quite a climbdown for a company that clocked 28 percent growth in 2022. Only a month ago, EPAM had lowered its 2023 revenue growth outlook to 3 percent from 9 percent given in February.

The latest cut in revenue guidance implies further deterioration in the business environment, a development that investors failed to gauge or simply ignored, although the March quarter results gave ample signs of the pain in the sector.

Constant currency revenues declined on a sequential basis at several large companies. Order bookings slowed. Managements have warned about a reduction in discretionary IT spends, project cancellations and delay in project ramp-ups. Yet, investors ignored the earnings risks and sent the Nifty IT index up 5.5 percent in the past one month.

“After careful assessment of changes in our May and June forecast data, we have come to understand that pipeline conversions are occurring at slower rates than previously assumed and we are also seeing some reduction in the total pipeline,” EPAM said in its investor update.

Of course, India-listed IT companies have more balanced portfolios with significant exposure to the maintenance expenditure needs of clients, which will go on anyway. But EPAM’s poor assessment of discretionary spending trends does not augur well for the revenue outlook for Indian IT, warn analysts at Kotak Institutional Equities. Part of the revenues of Indian IT services companies is derived from the discretionary spending budgets of clients.

Recent interactions between analysts and IT sector executives confirm the weakening outlook. Demand in this quarter so far has been subdued and spending caution is rising among clients. “IT firms indicated that more verticals are witnessing pressures given higher interest costs, inflation as well as weaker demand outlook, especially in the US,” analysts at Jefferies said in a note after talking to the managements of three large IT services companies.

Industry interactions by Motilal Oswal Financial Services also indicate pressure on near-term spends at large enterprises. Certain companies are even mandating their technology teams to cut costs, point out analysts. With trends indicating a weak June quarter and subdued H1 FY24, investors would do well to await firm recovery signs.

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