IT spend in US likely to remain resilient, large-caps like TCS, Infy & HCL safer bets

Though Indian IT companies have reported strong revenue growth in the June quarter, with most also maintaining or increasing their guidance, analysts remain cautious about the sector because of the concerns over a slowdown in the US, the biggest market.

The Nifty IT index has declined 23% so far this year, compared with a 1% rise in the main Nifty50 index, due to worries about slowing revenue growth, margin woes and elevated valuations of the companies.

“We believe the macro slowdown poses a risk that is likely to see a cut in legacy spending, as historically we have seen strong correction between customers’ revenue growth and technology spending,” said Vikas Ahuja, analyst, Antique Stockbroking. “Large companies such as TCS, and are safer bets to play the current volatility, while we suggest adding quality midcaps such as , , and LT Infotech on correction.”

There has been a significant underperformance of the IT stocks in recent months even though the earnings growth of the sector is currently in line with long-term averages, and the guidance by the IT companies is generally buoyant. Stock prices of

, , , L&T Infotech, Mindtree and , among others, have fallen between 25% and 40% so far in 2022. The one-year forward PE multiple of most of the companies are close to their historical averages.

Tech spending declined or were flat for major US banking companies like the Citi Group, JP Morgan and Wells Fargo, but up in the mid-single digit for Bank of America and double-digits for Goldman Sachs and Morgan Stanley, according to a report by Kotak Securities. Interestingly, the spending trajectory is stronger among the banks that sounded more cautious on expenses and future investments, the report said.

“Strong IT spending by the US banking and financial majors are positive for Indian IT companies. More fundamentally, we find a strong correlation between fixed investment in intellectual property in the US and the performance of Indian IT companies,” said Sujan Hajra, executive director, Anand Rathi Shares. “Fixed investment in intellectual property in the US is rising, which bodes well for Indian IT companies.”

While earnings per share would be supported by rupee’s depreciation, on margins and supply side cover, analysts expect hiring and attrition to ease off ahead.

If the US goes through a milder recession, then companies such as Mphasis, Birlasoft, L&T Infotech and MindTree should be able to maintain high growth rates given their order backlog, and hence there is a case for these companies to be in the core portfolio, said Mohit Jain of Anand Rathi Shares.