Brokerages lower growth outlook for IT sector

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Mumbai/Bengaluru: Slow growth and macroeconomic uncertainty have made brokerages lower their growth expectations from India’s $150 billion outsourcing sector with the number of equity analysts recommending technology companies’ stocks, including Tata Consultancy Services Ltd (TCS) and Wipro Ltd, to clients seeing a significant drop in the last two years, even as they continue to repose faith in Infosys Ltd.

A Mint analysis of over 60 analyst recommendations on the largest IT firms mirrors their stock performance as the Infosys stock is up more than 50% in the period between 31 June 2014 and 31 June 2016, even as TCS and Wipro are up 10.6% and 6.6%, respectively. During the same time, the BSE Sensex was up 6.24%.

Significantly, more analysts continue to have faith in Infosys at the end of June this year than two years back when Vishal Sikka was named as the first-non founder chief executive of the firm on 1 August 2014, even though fewer analysts are putting a “buy” rating on TCS and Wipro.

At the end of the June quarter, 50 analysts assigned a “buy” rating on Infosys (47 analysts held a “buy” rating at end of June 2014) while only 29 analysts and 17 analysts were advising clients to buy TCS and Wipro, respectively (49 analysts held a “buy” view on TCS and 32 analysts recommended a “buy” on Wipro at the end of June 2014).

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To be sure, Infosys under Sikka from October 2014 (first full quarter as CEO) has managed to grow its quarterly revenue by 13.6%, higher than TCS, which has grown its quarterly revenue by 11%, and Wipro, which has increased its quarterly revenue by 10.95%.

A more than 50% return for shareholders of Infosys means the Bengaluru-based company was the fourth-best-performing stock in the Sensex, behind Maruti Suzuki India Ltd (up 73%), Asian Paints Ltd (up 72%) and Hindustan Unilever (up 51%).

“Indian IT large-cap valuations, especially relative to the Indian market, suggest they are in the ‘unloved’ category, with investors already worrying about moderating revenue growth, falling margins, or both,” BNP Paribas analyst Abhiram Eleswarapu wrote in a note dated 1 July.

BNP Paribas has dropped TCS from its “buy” recommendations even as it continued to hold a favourable call on most IT stocks.

“Most large-cap stocks are trading at or below their five-year historical mean forward P/Es. Furthermore, their premia to the Sensex have shrunk to well under one-standard deviation below their historical means (except Infosys for which it is close to one-standard deviation below mean). We believe this suggests limited further downside, especially for those with less UK revenue exposure,” the note said.

Still, many believe that it will be an uphill struggle for the largest IT firms to record double-digit growth in 2016-17. Home-grown outsourcing firms’ traditional approach of outsourcing work to the cheaper locations is under pressure, as automation platforms and cloud computing erase labour arbitrage enjoyed by these firms.

Last year, Infosys reported a 9.1% dollar revenue growth to end with $9.5 billion in revenue, while TCS grew at 7.1% to end with $16.5 billion and Wipro inched up 3.7% to end with $7.34 billion in revenue.

Since 1 July until 24 August, the Infosys stock has dropped by more than 10% as a string of negative news has dented investor sentiment. Infosys reported a poor 2.2% dollar revenue growth in the April-June period, and sharply lowered its dollar revenue growth outlook in July to at-best 12.3% from 13.8% given in April.

Worryingly, the management earlier this month reported losing a large order from Royal Bank of Scotland Group Plc, further knocking down investor sentiment.

Still, Infosys can expect about $60 million (Rs.400 crore) in revenue over the third and fourth quarters, as the company readies the infrastructure under the Rs.1,380 Goods and Services Tax Network (GSTN) project. This development should encourage Infosys’s management, as this $60 million staggered payment translates to Infosys improving its current growth by at least 1% each in December and March quarters, which should offset the slowdown blues in the torrid second half of the year.