Should you buy IT stocks amid changing business environment?

The BSE IT index has shed over 3% year-to-date, compared with a sharp 12% gain seen on Sensex

Valuations of beaten down IT stocks could be turning attractive after a recent underperformance of the space amid technology disruptions, weak management commentaries and protectionist policies the world over.

As domestic IT majors look to realign their business model with changing needs, with Infosys already announcing 10,000 hiring in the US, experts believe any further dip in tier 1 IT names could be bought into for long-term gains.

The BSE IT index has shed over 3% year-to-date, compared with a sharp 12% gain seen on benchmark S&P BSE Sensex, with the top two IT companies TCS and Infosys tanking over 1% and 7%, respectively, while the third largest Wipro gaining a mere 4% during the same period. This is despite massive buybacks announced by IT firms, of late.  

The three big IT players have seen a muted single-digit dollar revenue growth in the March quarter - TCS (1.5%), Infosys (0.7%), Wipro (2.7%) - on account of growing protectionism in US, UK and Australia, as suggested by change in visa regime in these countries, currency headwinds and a slow catch up on digitisation and automation where global rivals have made an edge.

“Infosys came out with weak numbers. Numbers from TCS were marginally below estimates. Its management has not indicated any impact of Brexit, as yet, however, impact of investments in digital and potential visa /immigration costs on margins need to be closely monitored. Wipro also reported weakness in margins. It continues to be impacted by the lack of scale up in large accounts apart from the challenges in telecom and energy verticals,” said brokerage Kotak Securities in a research note.

Meanwhile, valuation of the IT stocks is at a 35% discount to their peak historical levels, and 15% below the long-term median levels, Apurva Prasad, Research Analyst (IT) at HDFC Securities noted.  

“In selected names, the valuations look attractive. One must look at it in the context of better capital allocation, which has improved return ratio of the stocks. Considering the fact that there are downside risks to earnings, valuations are closer to bottoming out,” he said.

Ankur Varman, AVP - Institutional Equity sales at SBI Capital Markets also said the IT stocks offer great value at this juncture.

“In our mind the possible impact (if any) because of visa issues is in the price and other headwinds offer more resistance,” he said.

The IT companies have been accelerating their onsite hiring for the last two-three years now, but the proportion has gone up after the US president Donald Trump proposed to tighten the H1B visa regulations in January, experts said.

“IT companies are increasing onsite hiring in anticipation of changes in visa regulations apart from the changing nature of the work requiring more onsite presence (closer to customer presence). The management of the companies maintained that accelerated hiring matches with the more high-end/valuable work and thus would not impact margins materially. Infosys’s FY18 margin guidance factor in this investment,” said Varman. 

Prasad of HDFC Securities, meanwhile, sees a silver lining. “The tightening of visa rules could be an opportunity for IT companies, because it will push them towards greater offshoring, leading to increase in the offshoring component,” he said. 

Infosys remains the preferred pick in the IT space. “Infosys is quoting reasonable valuations by trading at 10-15% discount to TCS even though it is likely to grow faster by maintaining or improving margins on relative basis,” said Varman of SBI Capital.

Infosys is trading at 13 times its FY19 earnings, while TCS at less than its 15.5 times FY19 earnings, said Prasad of HDFC Securities.

Among largecaps, Prasad also likes HCL Tech, which is scheduled to report its Q4 results next week.