IT Sector earnings review: Axis lists top hits and misses in Q2; picks 3 top stocks

The Indian IT services industry is facing near-term challenges due to the economic slowdown and weaker macroeconomic outlook. However, its long-term outlook remains robust with the economy showing signs of recovery. In a recent report, brokerage house Axis Securities said that it believes that the said recovery will begin in the second half of the year and FY24 will show strong revenue growth.

The brokerage has listed the key hits and misses for the IT space from the September quarter earnings as well as its top picks in the space post the earnings.

Hits and Misses

HITS during the quarter

• Despite the delay in automation spending, deal wins remained strong during the quarter. Many Indian IT service companies reported the highest-ever order book despite the lack of near-term visibility.
• The attrition rate has dropped as we see some easing on the supply side. This would help IT service companies improve their operating margins.
• Subcontractor costs are likely to weaken as demand weakens, which should have a positive impact on operating margins.
• Europe stood relatively strong as compared to North America. ER&D services remained resilient as compared to traditional IT services.

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MISSES during the quarter

• Growth visibility is likely to remain under pressure as the slowdown negatively impacts overall business activity.
• Delayed decisions have weakened revenue growth momentum, even if the deal wins remain resilient.
• Higher onsite expenses and rising costs have negatively impacted operating margins.
• Lack of visibility caused IT providers to slow down the hiring process, which impacted future revenue growth momentum.

What does FY24 hold for IT Services?

After strong revenue growth momentum in FY22 and FY23, Axis believes IT services may face challenges on demand and margin fronts on account of the economic slowdown and macroeconomic uncertainties. It has a skeptical near-term outlook for North America (40 percent of revenue).

It further pointed out that deal wins remained resilient even during the difficult times, which gives us confidence that automation spending will rebound strongly in two to three quarters. Demand in industries such as retail and manufacturing remains strong and is expected to regain momentum in the near future. Also, the demand for newer technology services such as generative AI, machine learning, IoT, and cloud transformations remains stable and is likely to recover more quickly as certain macroeconomic challenges subside, it noted.

Read Here: Five key trends in Q2 results revealed: Nuvama

The brokerage continues to believe that most IT services companies will regain momentum in the second half of the year as deal wins remain resilient and supply-side challenges ease. Many companies are becoming increasingly system-oriented and are unable to escape the costs of automation, thereby creating strong long-term demand, added Axis.

Key monitorables

• Any positive news from North America will lead to a sharp recovery in the Indian IT sector.
• Easing the banking crisis is expected to lead to higher confidence in automation spend and is likely to lead to a strong recovery in the BFSI vertical.

Top sector ideas: IT services

Post the September quarter earnings, the brokerage has listed its top 3 ideas from the IT services space – Coforge, Persistent Systems, and KPIT Technologies.

Coforge: The brokerage has a ‘buy’ call on the stock with a target price of ₹5,655, indicating a muted 0.5 percent upside potential.

“We are encouraged by the improved outlook in the vertical and engagement with clients gives us confidence in the company’s future prospects. TCV was strong in Q2FY24, with robust quarter-high deal wins at $331 Mn each in BFSI and Travel verticals. The US is seeing higher cost optimization deals while the Europe market remains impacted. As the macro environment stabilizes, the company expects decision-making to pick up. Coforge has also won deals across verticals indicating strong demand across geographies even during challenging times. It has strong execution capabilities and improved client engagement indicating a strengthened growth prospectus going ahead. Given the company’s strong growth potential, supported by solid deal-making and excellent execution capabilities, The recent stock has moved up however we remain confident about the company’s growth in the near future. We recommend buying on dips on the stock with the targeted price,” rationaled the brokerage.

Read Here: 5 key takeaways from September quarter corporate earnings

Persistent Systems: The brokerage has a ‘buy’ call on the stock with a target price of ₹7,200, implying an over 11 percent upside.

“Persistent Systems continues to report strong growth even during the challenging times with increasing client engagement. TCV in Q2 FY24 stood strong in Q2FY24 with deal wins at $479 Mn. The management is confident of gaining medium-term demand momentum on the backdrop of the deals it has won in the previous quarters. It also expects improvement on the margin front. The UK is seeing higher cost optimization deals (with faster decision-making), while the European market continues to be impacted. As the macroeconomic environment stabilizes, the company expects decision-making to pick up. We believe Persistent is well positioned to encourage growth given its numerous long-term contracts with the world’s leading brands. Improved revenue visibility gives us confidence in the company’s continued growth,” Axis said.

KPIT Technologies: The brokerage has a ‘buy’ call on the stock with a target price of ₹1,700, implying a 13 percent upside.

“While the aggregate global market in value terms for medium & heavy commercial vehicles is smaller than passenger vehicles, the commercial vehicle category is especially relevant from an autonomous driving and electrification standpoint. The key variable costs for fleet operators in the CV arena are driver cost and fuel. Autonomous driving technologies and electrified powertrains are cutting costs and making trucking and logistical service operations more cost-effective and profitable. Digital engineering spending is accelerating across industries, and companies moving from traditional to digital engineering will quickly adopt digital engineering. Major industries such as Manufacturing, BFSI, Media and Technology, Retail, Healthcare Payers & Providers, and Travel & Hospitality are developing new products and services to differentiate themselves in their respective industries, thereby creating remarkable opportunities for the company,” explained the brokerage.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decision.