Earlier this week, the global brokerage firm JP Morgan 'downgraded' the Indian information technology (IT) sector over margin and revenue concerns, alongside surging inflation and supply chain issues in the Russia-Ukraine tussle.
The global brokerage firm has downgraded Tata Consultancy Services, HCL Technology, Wipro, and L&T Technology to 'underweight' from 'neutral' and slashed its target price by 15-21 per cent, but maintained an 'overweight' rating on Infosys, Mphasis, and Tech Mahindra, with reduced target prices.
Why, though?
The firm said that 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 due to the high attrition rate and talent management that has pushed up costs of hiring and retaining employees.
JP Morgan's Ankur Rudra and Bhavik Mehta said that the rising margin headwinds in the near term and revenue headwinds in the medium term from potential macro slowdown would mean that the sector's earnings upgrade cycle is behind.
Goldman Sachs also warned that there was a 30 per cent chance the US economy would tip into recession over the next two years due to aggressive interest rate hikes by the US federal reserve. Other firms such as Wells Fargo and Morgan Stanley believe a recession in the US is around the corner as the US Fed shows no signs of easing its fight against high inflation.
Meanwhile, Kotak Equities said 'what is priced into stock' is a risk to margins. What is not priced in is 'economic recession.'
The company has trimmed its fair value targets for nine IT stocks under its coverage by 2-14 per cent, assuming a moderate slowdown in demand for IT services.
S&P Global rating slashed India's growth forecast to 7.3 per cent from 7.8 per cent for FY23 on rising inflationary pressure and the prolonged Russia-Ukraine war.
Wait, a twist
Interestingly, the US market contributes 40-78 per cent of revenues for Indian IT companies. This includes TCS, Wipro, HCL Technologies, Infosys, and Tech Mahindra, having more than 50 per cent exposure.
On the bright side, this can also be a blessing in disguise for Indian IT companies, as the majority of them are likely to cut costs abroad and outsource work to countries like India, the Philippines and others because of the cost benefits/advantage. In addition, some experts said that thanks to the recession and rising inflation, companies can now focus on offering better services to their customers, as the innovations and other R&D related work takes a backseat.
Is the Indian IT sector recession-proof?
The Indian IT sector has always had higher resistance than the rest of the world. This includes the 2008 financial crisis, the dot-com bubble, the pandemic, and others. Moreover, the fundamentals of some of these IT companies are at an all-time high.
Here's a quick overview of the top IT firms in India, showcasing the P/E ratio and sales growth in the last five years.
Kiran Kumar S said during 2021-22, Infosys clocked 19.7 per cent revenue growth – it is the fastest in 11 years. "Many more companies performed very well, the same way," he added, saying that the Indian IT industry saved the economy during a Covid downturn.
If not the IT sector, then what are the alternatives?
While JP Morgan has 'downgraded' the Indian sector to 'underweight' and slashed the target price of multiples by 10-20 per cent, the question is, which are the alternate sectors that are bound to generate revenues amid the recession?
The JP Morgan report stated the bottom-up outlook remains positive from most services, software, and SaaS names YTD. The tech spending cycle remains buoyant structurally. "We feel there are more downside risks to current earnings assumptions," it added.
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