Infosys, TCS, Mphasis: IT stocks rally amid positive global cues, but when is the real recovery happening?

Stock market today, IT stocks, US inflation: The domestic equity market looked like a sea of green on Wednesday, November 15, as healthy buying was seen across the board. IT services shares were in demand after the tech-heavy index Nasdaq in the overnight trade posted its biggest daily percentage gains since April 27 as softer-than-expected inflation data supported the view that the Federal Reserve may be done raising interest rates.

Data showed US consumer prices were unchanged in October. In the 12 months through October, the CPI climbed 3.2 per cent—below economists' estimates—after rising 3.7 per cent in September, according to a Reuters report.

The S&P BSE Information Technology index rallied 2.04 per cent to settle at 32,022.51 levels. The top five IT companies' shares—Infosys, TCS, Tech Mahindra, Wipro, and HCL Tech—all traded with impressive gains. Besides, small and midcap IT companies such as Quick Heal Technologies (up 5 per cent), and Mphasis (up 5.53 per cent), among others, also traded in positive territory. Meanwhile, the benchmark index, Sensex, jumped 742 points, or 1.14 per cent to close the session at 65,478 levels.

What lies ahead for IT services companies?

IDBI Capital, in its Q2 results review note, said that Q2 FY24 has seen challenges due to current macro conditions, which have impacted the revenue growth of IT companies.

Although IT companies are witnessing strong deal wins led by cost-takeout deals, annual contract value (ACV) is still lower (despite high total contract value, or TCV) due to longer-tenured deals, pricing, and the transition effect. In addition, a slowdown in discretionary spending and new short-term projects is hampering growth. However, despite headwinds, midcaps have outperformed large caps, the domestic brokerage said in its report issued on November 10.

Cost takeout refers to eliminating unnecessary expenses from a business through strategic planning. Strategic cost takeout involves reassessing a company's cost structure and making necessary changes to it, explains the Infosys Knowledge Institute.

The brokerage added that the revenue outlook looks muted for the IT companies in the near term considering furloughs in Q3 and budgeting in Q4. Cancellations, delays, and reprioritisation continue to impact discretionary spending. "In the near term, we expect weakness in the American region to continue. This is further evidenced by the fact that Infosys has cut its guidance and Wipro has weaker-than-expected guidance.

"We expect the exit of Q4 and mega deal wins will be key indicators of FY25E growth. We expect mid-caps to continue to outperform large caps (considering their diversified presence, which will make them more susceptible to macro shocks across sectors)," the brokerage said.

Midcaps have seen -0.6 per cent–4.6 per cent QoQ revenue growth against -2.9 per cent - 2.2 per cent in large caps. IDBI Capital is positive on Newgen, Birlasoft, and Cyient among mid-cap companies in its coverage universe.

Analysts at Kotak Institutional Equities, in their November 1 report, wrote that their analysis of earnings calls commentary of US and European BFS firms indicates a continuing focus on expense management leading to planned headcount reductions or/and restructuring in several cases. Cost management measures can lead to closer scrutiny of tech budgets, impacting a recovery in discretionary spending and consequently growth in CY2024.

The brokerage expects more large-cost take-out opportunities for Indian IT. TCS, Infosys, HCLT, and, in select cases, LTIM, Mphasis, and Coforge are better positioned. Weaker vendors in the client ecosystem are at higher risk of being impacted by cost take-outs and the continuation of the insourcing agenda of select firms. "Wipro and Cognizant Technology Solutions are vulnerable, in our view," they say.