IT stocks could underperform from here on

IT majors Tata Consultancy Services and Infosys started the Q4 results season for large-cap companies this week.
While TCS posted steady growth aided by mega-deal wins, Infosys missed analyst estimates on slower revenue, fall in profit. 
However, both the companies said they foresee a resilient demand environment in FY23 and a strong deal pipeline, but admitted that margins will continue to be pressured.
For instance, Infosys’ margin guidance at 21-23 per cent for FY23 is 100 bps lower than its earlier guidance in FY22.
 
Going ahead, Nomura sees the company’s margins dropping in the new fiscal as, “Headwinds of high fresher hiring, competitive salary increments and, efforts to further drop utilisation towards its comfort zone of 85% from 87% in 4Q will be front-loaded for Infosys in FY23.” 

Independent market analyst Ambareesh Baliga believes that going ahead the trend of subdued margins could be mirrored across the entire IT pack, including mid-size companies.

Brokerage HSBC Global also sees limited upside to the sector’s revenues in FY23 and 24 as margin pressures remain more precarious than the top-line. 
The brokerage believes that while some moderation in wage hikes will occur in FY23, the tailwinds will be limited as travel and other costs are likely to come back to some extent.

That said, it has slashed its valuation multiples on Infosys and TCS by 10%, along with reducing the target prices. It has further downgraded its rating on Infosys from buy to hold, while reducing FY23 and FY24 earnings estimates for TCS by 4.6% and 4%, respectively.

At the index level, analysts at ICICI Securities expect that the Nifty IT index, which has been resilient so far this year despite a weak macro environment, may soon begin underperforming the Nifty 50 due to slowing revenue growth, margin woes and elevated valuations.
 
They say, “Nifty IT index might end up with negative returns in FY23 and multiples for the sector are unlikely to rerate given the impending margin issues and a potential slowdown in discretionary spends due to macro reasons. Additionally, rising interest rates are driving up the cost of equity and should put pressure on stock prices.” 
 
That said, markets will remain closed today on account of Good Friday holiday. When trading resumes on Monday, stock action for Infosys will be eyed, along with that of banking major HDFC Bank, which will post its Q4 results tomorrow.