IT stocks fall as Nomura, JPM flag growth worries

BSE IT index drops 3.2%; mid-caps see deeper cuts

The technology pack saw a fresh sell-off on Wednesday after Nomura warned of a sharp deceleration in growth rates for the sector as companies scale back their tech spending amid a challenging macroenvironment. The brokerage downgraded several stocks in the sector and reduced their target prices between 16 and 38 per cent.

Nomura’s report comes just days after JP Morgan warned of “dark skies” for the domestic IT sector as it believed “peak revenue growth behind us and Ebit margins trending down from inflation, mean reversion.”

The BSE IT index fell 3.2 per cent, extending its year-to-date sell-off to 26 per cent. Stocks in the mid- and small-cap IT universe saw a sharper decline, given their valuation premium to larger peers.

“We think enterprises’ willingness to spend on digital transformation will continue but growth rates on spends are likely to decelerate, constrained by revenue and earnings volatility. Our study of revenue and earnings profiles of 750 listed companies suggests a material slowdown in the overall financial performance in the upcoming quarters. We see a strong correlation between financial performance of the sample set and IT services revenue with a lag of 1-3 quarters (depending on the sector), indicating a potential slowdown for IT services demand in FY24,” said Nomura in a note.

The rally in the IT stocks was underpinned by sharp year-on-year growth in revenues during FY22. The top-tier tech stocks saw average growth in revenues of close to 20 per cent, while tier-ii companies saw growth of 25 per cent.

Analysts are expecting revenue growth for large-caps to fall to 13 per cent in FY23 and to below 10 per cent in FY24. To make matters worse, even companies are expected to face margin pressures. This has prompted analysts to assign lower earnings multiples.

“In the near term (FY23F), we expect headwinds to be higher than tailwinds for the sector, notwithstanding the recent depreciation of the rupee versus the dollar. Extremely volatile capital markets and rising interest rates have started to dry up liquidity for start-up companies globally. The rising firing of employees (in an endeavour to save capital and demonstrate a path to profitability) and hiring freeze is also likely to slow down the unprecedented demand for tech talent in the coming quarters, in our view,” Nomura has said.

IT has been one of the best-performing sectors in the post-pandemic era as disruption caused by Covid-19 lockdowns forced companies to automate and increased tech spends. This sent trading multiples for several stocks in the sector to record highs. After this year’s fall, the valuation excesses have come down but analysts believe they are still higher given the change in growth dynamics.

“Indian IT growth was accelerating till Q3FY22 and has begun to slow down from Q4FY22, which is likely to worsen into FY23 from the tougher competition, supply issues, and eventually a worsening macro. With peak sector growth behind, growth deceleration should continue to weigh on sector multiples,” says the note by JP Morgan.