IT stocks catch cold as Trump warms up to outsourcing curbs

Valuation gap between top IT stocks and Sensex widest since 2009 on low export growth fears

Trumponomics is adding to the expenses for India’s biggest information technology (IT) exporters. 

Fear of lower export growth to the US has made IT companies among the cheapest stocks on the bourses. The valuation gap between software service firms’ stocks and the benchmark Sensex on the BSE is at its widest since March 2009. The top five IT companies are trading at a trailing price-to-earnings multiple (P/E) of 16.7, against the Sensex’s multiple of 22.1.

In contrast, IT stocks had led the valuation charts during the better part of the past decade. 

The change is, actually, largely due to gross underperformance by IT stocks, despite bullishness in the broader market. The top five IT companies have lost 6.6 per cent of their market capitalisation in the past 12 months; in that period, the benchmark index rose 16.7 per cent.

Infosys has been the biggest laggard, down 14.2 per cent in these 12 months. Wipro is down 10.1 per cent. Sector leader Tata Consultancy Services (TCS) has done relatively well, delivering a 6.9 per cent return; but, well below the return in the broader market. It is followed by Tech Mahindra (up 6.6 per cent) and HCL Technologies (up 3.5 per cent).

The current valuation squeeze in the sector seems more severe than the previous episodes in 2008 and 2009, when it was hit in the aftermath of the global financial crisis. 

The announcement of a share buyback by TCS provided only marginal relief to the sector’s valuation. The sector’s P/E is up marginally since the low in December 2016. 

The big five IT exporters in the Business Standard sample were together sitting on cash and equivalents worth around Rs 93,000 crore at the end of March 2016, equivalent to nearly 10 per cent of their combined market capitalisation and 45 per cent of their net worth (or shareholder equity) in 2015-16. The top five are now worth Rs 10 lakh crore down; in end-September 2016, it was Rs 11.1 lakh crore.

 

In stock valuation charts, IT companies are now clubbed with slow-moving and low-return segments such as power & gas companies (utilities in market parlance) and oil & gas companies. This is despite a big gap in the return on equity (RoE) of IT companies and the others. In FY16, the big five in IT reported RoEs from a low of 22 per cent for Wipro to TCS’ 42 per cent. In comparison, the RoE for most utilities and oil & gas companies was either in single digits or low double digits, with the exception of Bharat Petroleum Corporation (BPC) and Hindustan Petroleum Corporation (HPC). These two refiners reported a record high RoE in FY16, due to a sharp drop in crude oil prices.

Analysts attribute this to lack of earnings visibility for the IT sector and visa uncertainty after Trump’s victory in the US, the largest market for this country’s IT exporters. 

“The larger IT stocks are trading at well below their three-year average PE and close to their three-year lows. Trump’s anti-immigration rhetoric and recent comments pose uncertainty for the sector,” wrote Credit Suisse’s Anantha Narayan and Nitin Jain in a recent report. This has turned many investors away from IT to other sectors. 

“IT companies face a lot of uncertainty right now and sectors such as financials offer better opportunity right now,” says Dhananjay Sinha, head of institutional equity at Emkay Global Financial Services.

On the brighter side, many brokerages are turning bullish on the sector, again due to the continued underperformance by IT companies on the bourses. “I find tech stocks cheap and the market has become too pessimistic on them. If US growth is accelerating and wage inflation is rising, then Indian IT companies are in a sweet spot, as American companies have to outsource, notwithstanding the policies they would have,” Ridham Desai, head of India Research at global brokerage Morgan Stanley, recently told this newspaper.

“Historically, Indian IT companies’ revenue growth enjoyed a strong correlation with US corporate profits, with a lag. The good news is that US corporate profits have turned around, which should boost demand, improving the top line growth for IT companies,” writes Edelweiss Securities’ Kapil Gupta and Prateek Parekh in a recent India equity strategy report.