Despite some slowdown, the outlook for IT firms appears reasonable

Weak rupee, recovery in US, lower valuations and domestic market volatility are tailwinds

Tata Consultancy Services (TCS), Infosys and Wipro all declared their Q4 results last week and the analyst opinions and market response were both mixed. While TCS and Infosys lost ground, Wipro saw strong buying. Here are some of the things investors must consider when looking at the IT sector.

Wipro beat expectations reporting the best Q4 results in several years. Infosys saw weak quarter-on-quarter (QoQ) growth in revenues and marginal contraction in profits. This was below expectations. TCS disappointed the street going by a sell off after it had reported Q4 results, even though it seemed to deliver a reasonable performance by objective standards.

All three companies have released optimistic projections for 2021-22. All three also saw strong deal wins in 2020-21. They are bellwethers for the IT industry since most of the second-tier IT companies seem to perform in line with the big firms. A fourth biggie, HCL Technologies, often has divergent performances because it has exposure to the infrastructure sector.

The rupee strengthened versus USD between January 2021-March 2021, moving from around Rs 73.5 in January to Rs 72.5 in March. However, it has dipped sharply in April, testing the Rs 75 mark. Most forex advisories suggest that the rupee is likely to weaken further in 2021-22, given a combination of higher domestic inflation, strong crude and gas prices, and a high fiscal deficit, with a huge government borrowing program. This is good for exporters obviously.

However, there is margin pressure and the growth in services could see a slowdown in momentum. Most analysts seem to believe that the industry may however deliver double-digit growth in both topline and bottomline. This has led to an apparent re-rating for Wipro. Infosys has a buyback worth about Rs 9,200 crore in the offing and TCS has completed a buyback of about Rs 16,000 crore in January.

TCS also announced a Q4 dividend of Rs 5,500 crore, which takes total dividend for 2020-21 to around Rs 14,000 crore. This will however, deplete cash reserves and this could be worrying since there’s been a slowdown in organic growth rates. Lower reserves may hinder growth via acquisition.

Net-net, IT sector growth should be reasonable in 2021-22. There may be some slowdown balanced off to some extent by a weaker rupee. The growth prospects look reasonable for the US and more broadly for North America, which is the single largest geography for IT companies. One reason why investors will be interested is that IT could provide a hedge against domestic economic disruption caused by the current second wave.

The NSE IT Index, which tracks 10 stocks, has outperformed the Nifty 50 in the calendar year and in the past 12 months. It has had a recent correction which ended when Wipro pulled the index up on Friday. The IT Index is also trading at current PE (last four quarters, free-float) of 28.5 which is lower than the Nifty PE of 33.