IT stocks under stress as JP Morgan reiterates 'negative' stance; Infy, TCS lead fall

Shares of IT services companies remained under selling pressure for the second straight session on Thursday after foreign brokerage firm JP Morgan reiterated its negative stance on the sector. IT sector heavyweights Infosys, Tata Consultancy Services (TCS), Wipro, Tech Mahindra, LTIMindtree fell up to 1% in early trade on the BSE, while the BSE benchmark Sensex was trading marginally higher.

Infosys, the country’s second largest software exporter, topped the losers chart with a 1.1% loss, followed by the most valued IT firm, TCS, which was down nearly 0.8%. Among others, Wipro, Tech Mahindra, LTIMindtree shed up to 0.5%, while HCL Technologies gained 0.7%. Overall, the BSE IT index was down 0.4%, while BSE Sensex was trading 18 points, 0.03%, higher at 63,246 levels.

The sell-off in IT stocks was triggered after the U.S.-based JP Morgan downgraded the Indian information technology (IT) index to 'underweight' from 'neutral' earlier, citing the overall demand environment for the sector still remains weak. The agency expects most IT services firms to miss current expectations and placed Infosys, TCS and MphasiS on negative catalyst watch.

“We expect demand weakness to intensify in Jun quarter. We feel project deferrals, halts, cancelations, drawdowns are likely to persist in 1QFY24 without clear signs of a bottom. Such weakness is likely to be felt most in discretionary project spend areas in Apps, DX, Engineering with lower impact on legacy managed services,” the brokerage said in its report.

JP Morgan, in its report, said increased competition for a smaller pie could trigger falling win-rates, pricing and deteriorating deal terms. Adding to it, paused projects might have limited visibility of restarting and signs of demand recovery over the next 6-9 months could be low, potentially driving H2 growth expectations lower and FY24 industry growth to sub 5% YoY levels (from its previous 4-7% post 4Q results), it added.

The brokerage has placed TCS on negative catalyst watch and kept the price target unchanged at ₹2,700. It has cut FY24-25E revenues and earnings by 1% and rolled forward to Mar’24. “We remain UW on the stock (TCS) as we bake in lower growth from macro concerns in FY24E that will also limit significant margin expansion. Moreover, the unexpected CEO departure could lead to periods of volatility in a time of weaker tech spend and rapidly evolving macro,” the report noted.

The agency has also placed Infosys on negative catalyst watch with a price target of ₹1,150, cutting revenues and earnings by 1-2% over FY24-26E. “Our UW thesis is driven by three main factors: (1) lower growth expectations in FY24 of ~3% CC YY, belo the lower end of the company’s guide of 4-7%, as we believe 1H will be weak, given the uncertain macro, and 2H won’t be able to carry the burden of lifting full-year growth; (2) weak leading indicators in the forms of declining net new large deal TCV and a sharp slowdown in hiring, suggesting weaker growth ahead; and (3) Infosys’s loss of growth leadership to TCS in 4Q23, while slipping margins are not yielding a growth advantage,” it said.

On HCL Technologies, the brokerage remained UW (underweight) and rolled forward to Mar’24, with a revised price target of ₹900 from ₹880 earlier. “We believe HCL’s P&P diversification has complicated its equity story and diluted organization-wide performance management. It has likely driven underinvestment in digital (lowest among peers) and masked margin dilution in its core IT services business. We see it as a source of avoidable drain on capital allocation and management resources when the core IT services industry growth is at a multi-decade high,” it said.

It has also maintained UW rating on Wipro and rolled forward to Mar’24, with a target price of up to ₹360 from ₹350 estimated earlier. “Wipro’s weak 1Q24 guide highlights the challenging macro environment that will lead to a sharp slowdown in growth in FY24E and keep it under pressure in the absence of operating leverage, in our view. Wipro’s higher consulting exposure keeps it at a higher risk of slowdown than peers,” it said.

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