Analysts prefer these 5 IT stocks ahead of Q2 earnings

After pharma, technology sector has been the second biggest gainer this year so far. The reasons for this outperformance have been many, including increase in digitalisation due to COVID-19, strong deal pipeline, least impact on operations by lockdowns worldwide, lower travel cost due to work from home culture, freeze in hiring and lower discretionary spend.

The Nifty IT index has jumped 27 percent year-to-date and 77 percent from March 23's low. Meanwhile pharma index is up 46 percent and 82 percent in same periods, respectively.

"IT companies are witnessing healthy deal wins & deal pipeline led by vendor consolidation opportunities, acquisition of captives, and offshoring & automation. This gives visibility of revenues over coming quarters. Further, IT companies have also rationalised cost by reducing travel cost, no wage hike, hiring freeze, pyramid rationalisation and lower discretionary spend which is expected to keep profitability healthy," Pankaj Pandey, Head – Research at ICICI Direct told Moneycontrol.

As a result, he expects IT to be a star performer in the current times.

Siddhartha Khemka, Head - Retail Research at Motilal Oswal Financial Services also feels IT will stand-out tall this year as one of the few sectors as far as Q2 earnings are concerned.

"While rest of the sectors posted 20-30 percent earnings decline in Q1, IT looked relatively resilient with 5-10 percent earnings growth. The momentum will continue in Q2 as well especially after good guidance given by few large and midcap companies," he explained in its report High Conviction Basket - IT.

He expects series of earnings upgrade this quarter (Q2) ranging between 5 and 10 percent for large-cap IT names.

Both commonly bet on five recommendations, which are Infosys, Tech Mahindra, Wipro, Mindtree and Coforge.

Pankaj Pandey is also betting on Birlasoft and Sonata Software, while Siddhartha Khemka's other picks are TCS and L&T Infotech.

Khemka feels these stocks ideas from the IT space are expected to do well in the short to medium term.

From a longer-term perspective, for IT segment, Pankaj Pandey feels one of the structural changes that is witnessed amid COVID-19 times is virtualisation of business.

"This coupled with new age technologies like cyber security (to protect business from work from home scenario), app development (to help customers transact virtually) and Cloud (to bring entire business online) are gaining prominence in making the business model virtual," he said.

He believes most of the companies have been at a very nascent stage in making its entire business model online. He expects technology to become an integral part of a company's spending and key to revenue growth. Hence, he expects increased allocation towards technology making IT a structural story in the long run.

Motilal Oswal explains reason behind these stock ideas:

Infosys: Infosys delivered strong beat on both revenue and margin front in its Q1FY21 earnings. Deal wins and the deal pipeline both remains healthy. The brokerage expects further expansion in margins as investments stabilize and back-ended productivity benefits kick in.

Tech Mahindra: Ramp-up in recently won mega deals was largely on track, a key positive. Motilal Oswal upgraded EPS estimates over FY21–22 by 17 percent as it revisited growth and margin trajectory in light of the surprise in Q1FY21 and optimistic commentary. The brokerage believes the sector re-rating is likely to sustain given the phenomenal resilience and adaptability demonstrated during the quarter.

Wipro: The brokerage believes Wipro is a good re-rating candidate due to the (a) upside of a turnaround under the new CEO, (b) possibility of an impending buy back, and (c) relatively attractive valuations (versus TCS and Infosys, 13x 1-year forward P/E) and (d) possibility of large capital return. Despite the COVID-19 impact, margin resilience/cash generation was impressive this quarter.

Mindtree: The strategy change to increase focus on annuity revenue and tail account rationalisation is already reflecting in the revenue and client mix. The share of revenue from fixed-price contracts showed a meaningful increase in Q1FY21. (1) Continued robust outlook for the top account, (2) decent deal signings, and (3) strong margin execution are key positives.

Coforge: Coforge delivers services around the world directly and through its network of subsidiaries and overseas branches. The Company is rendering IT solutions and is engaged in Application Development and Maintenance, Cloud Computing and BPO services to organizations in a number of sectors. The company has excellent return ratios of RoE-21 percent and RoCE-27 percent and has a very good growth potential going forward.