IT stocks rally as Morgan Stanley upgrades rating; sector set for revival

US-based brokerage says 2018 will be year of turnaround for the IT pack; Favours large-caps

Large-cap information technology (IT) stocks rallied on Tuesday on the back of a rating upgrade by influential brokerage Morgan Stanley. Shares of Tata Consultancy Services (TCS), Infosys and Wipro gained around four per cent each after the brokerage revised upwards their price targets between five per cent and 26 per cent.

"Indian IT services stocks could be set for a turnaround in 2018," said Morgan Stanley analysts Parag Gupta and Gaurav Rateria in a note dated January 15. "Valuations are at or below long-term averages and an improving global macro could spur tech spending, which could re-rate stocks," the duo said adding that they prefer large caps.

Shares of mid-cap IT stocks underperformed with Mphasis, Cyient and Mindtree ending with losses. The benchmark Sensex ended 72.5 points, or 0.2 per cent lower, even though TCS, Infosys, and Wipro made a 158-point contribution. The BSE IT index gained 3.3 per cent and was by-far the best-performing sectoral index.

The technology pack has been underperforming the market in the past few years amid slowing growth and regulatory concerns. Last year, the BSE IT index gained only 11 per cent even as the Sensex rallied 28 per cent.

"IT underperformed the Sensex in 2017 as revenue growth was tepid while investment in the business and a strong rupee kept margins in check. While management commentary on deal pipelines and spending intentions were upbeat through most of 2017, it did not translate into deal wins and growth thus impacting both sentiment and stock performance," Morgan Stanley said in the note.

The brokerage said its recent proprietary global survey of chief technology officers (CIO) pointed towards an acceleration in IT services growth spends.

"European geography has been strong and North America is likely to pick up in mid-2018 as banking clients start to spend. Digital deals have started bulking up (from a few million dollars to $40-50 million) and adoption is deepening, which could improve revenue growth rates and visibility," the note said.

Market players said the Morgan Stanley note and weakening of the rupee helped improve sentiment towards the IT stocks, which have been laggards over the past three years. Also, technology shares could outperform the market if returns taper off following a stellar year, they added.

"We believe a turnaround in IT spending is imminent, which could quickly turn sentiment on these stocks. While structurally the sector faces risks from automation and a slower pace of market share gains from global vendors, we believe a cyclical rally could be in the offing," the note added.

Morgan Stanley upgraded Infosys, Tech Mahindra, and HCL Tech to 'overweight' from equal weight'. It upgraded TCS to 'equal weight' from 'underweight' and remained 'underweight' on Wipro. In terms of price targets, Infosys and Tech Mahindra could see the maximum upside from current levels. The brokerage says valuations for these three companies are below their long-term averages. TCS it said was trading at a premium to peers with a valuation of 19 times its estimated earnings for next fiscal (FY19).

Morgan Stanley said its bullish projections for the IT pack could go wrong if there is a "push out" in tech spends or if there is appreciation in the rupee or renewed concerns on regulations, especially US visas or new tax laws.