Indian equity markets have corrected sharply amid escalating geopolitical conflict between Russia and Ukraine. While the benchmark Nifty 50 index has plunged more than 6 per cent so far this year, the Indian information technology (IT) sector gauge, Nifty IT, has corrected by around 14% as concerns around rising interest rates hit technology stocks globally. The recent correction, however, could be giving investors an opportunity to add quality stocks to their portfolio at reasonable prices.
“While IT sector valuations are above historical averages, they are back to pre-Covid levels on a growth adjusted basis. The sector is currently implying a long-term INR growth rate of 12%, which looks reasonable, at least in the medium term. Hence, we recommend investors to consider the recent correction as a good entry point,” said IIFL Securities in a note.
IT sector offers over 15% shareholder returns in medium term
According to IIFL Securities analysts, valuation multiples for the Indian IT sector are back to pre-COVID levels after adjusting for the future growth trajectory, i.e. on PEG basis. It is now at a 6% discount to its average pre-COVID PEG. “Large-caps are more attractive on PEG multiples, while mid-caps offer higher compounding. Premium to the broader market has endured, and justifiably so in our view, given the strong earnings visibility and demand up-cycle that the sector is witnessing,” the brokerage said in a note. It further highlighted that the sector is offering more than 15 per cent total shareholder returns in the medium term, given the strong capital allocation track record.
15% US$ revenue growth estimated in FY23
IIFL Securities estimates the IT sector to deliver at least 15% US$ revenue growth in FY23ii vs. 19% in FY22ii, as pent up demand is transitioning into structurally higher growth. “We believe the Street may continue upgrading FY23 estimates, as visibility improves over coming months. There may be margin pressures led by supply-side constraints, but would be largely offset by strong growth and pricing improvement in the medium term, with INR being a wild card. Hence, we do not see risks of margin resets,” the brokerage report said.
Overall growth outlook intact, no signs of slowdown in demand
The brokerage remains positive on the sector because interactions with IT companies at the recent IIFL Conference suggest that the overall growth outlook for the sector remains largely intact, with no signs of a slowdown in demand. “News-flow on deal-win announcements continues and the deal pipeline remains fairly robust. Despite a strong exit to 2021 and 3QFY22, CEOs highlighted that demand should remain strong in 2022,” it said. While supply-side pressures remain elevated in the near term, companies believe that fresher hiring and wage corrections should ease it off in this calendar year 2022.
IT stocks to buy amid correction
IIFL Securities analysts prefer Infosys and Tech Mahindra in large cap stocks and PSYS Technologies, Mindtree in mid-caps. “We continue to favour Infosys as our top large-cap pick. We note that the laggards have gone back to their valuation discount vs. Infosys in the recent correction, but Infosys is still at an 8% discount to TCS on 1YF P/E, as TCS found support due to its on-going buyback,” the brokerage said. Second large cap pick Tech Mahindra has corrected recently despite posting 3 strong quarters and a stable outlook.
“Among mid-caps, we continue to favour PSYS as our top pick, as it has the highest scope of earnings surprises, while MTCL has de-rated the most despite delivering strong growth with resilient margins,” it added.
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