Share prices of Indian IT companies have seen a sharp correction recently with the Nifty IT index down 27 %so far this year (CY22). Midcap IT stocks like L&T Technology Services, L&T Infotech, and Tech Mahindra have corrected between 40-45 % while larger names like TCS and Infosys have corrected by 12-22%.
Also, U.S. Tech stocks have fallen quite sharply with the Nasdaq 100 down 25 % on a YTD basis. The earnings estimate of top U.S. tech companies has fallen over the last month on growing expectations that the Federal Reserve’s aggressive path of interest-rate hikes will trigger a recession.
The valuations of Nasdaq 100 have corrected drastically and the index is now at 19x 1-year forward earnings. This is – almost the lowest since the start of the pandemic. The peak PE for Nasdaq 100 was 31x after the Fed released a massive stimulus.
The reasons for a sudden change in the sentiments are broad market weakness and increasing concerns regarding a hit on client IT spending which in turn is a result of the weakening global macro hit by higher inflation, further compounded by the geopolitical crisis in Ukraine. Increasing concerns regarding the U.S. slowdown/recession are leading to worries about the potential impact on client IT spending.
This has resulted in a cooling-off in valuations after the strong re-rating that the sector has seen in the past 18 months. While the worsening economic activity is the dominant discussion, the demand environment for IT services continues to be reasonably good.
While macro risks remain, management commentary on the spending, imperative by global peers, and Indian names in the recent past, provides some relief. The commentary from both Indian Techs as well as global techs in recent weeks seems to suggest that the clients continue to remain committed to their tech initiatives.
Demand is holding up very well and the industry is not seeing any signs of delays in terms of new deal signings/closures or any delays in ramp-ups. In fact, IT spending may hold up better even in case of a global recession. The recessions that the markets experienced during the Global Financial Crisis in 2008 and the Covid pandemic in 2020 taught us that IT services spending recovered swiftly once recovery started in the economy.
Companies across industries increased their tech spending to optimize operational costs or derive competitive advantages which led to an uptick in tech spending. In fact, in a global recessionary environment, Indian IT is better placed to capture more growth opportunities as global clients seek additional cost savings.
This has a positive effect on the operational/PAT level for IT companies. In the past, we have seen a sharp rupee depreciation during the recession period. TCS in their FY22 Annual report has suggested that the tech spending is holding up during the downturn, suggesting that ‘Tech is central to an enterprise with businesses being rooted in tech.
Thus, the Tech spending is on a secular upward trajectory; however, a potential macro slowdown may weigh in on growth in CY23/FY24.’
From an investment perspective, investors can start nibbling on large-cap names of Indian IT along with a few larger midcaps. In the U.S. Tech space, investors will be better off focusing on mature technology companies like Microsoft, Google, and other developed and profitable companies. One should avoid the trap of investing in new-age technology companies, both in India and overseas.
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