Recession fears can pull IT stocks lower

Mumbai: Indian IT stocks may remain out of investors' favour in the near term as growing concerns over recession in the US and Europe could erode companies' earnings growth. Analysts see a likelihood of further downgrades with companies' profit margins expected to come under pressure over the next few quarters.

The Nifty IT index declined 3.5% on Monday, its highest decline in two-and-a-half months after the US Federal Reserve Chairperson Jerome Powell on Friday emphasized that the central bank's priority remains controlling inflation even if higher interest rates lead to lower economic growth. Investors fear a slowing economy could lead to lower technology spending in the US and Europe. , , , L&T Infotech, and fell more than 4% each on Monday.

"Increasing macro concerns and a slowdown in GDP growth, rising inflation in the US and Europe - the largest geographies for Indian IT Services, and ongoing geopolitical tensions are resulting in a near-term uncertainty in the Indian IT services space spend from retail vertical," said Mukul Garg, analyst at . "A weakening macro environment may translate into lower IT spends and slower growth for Indian IT companies."

According to Bloomberg consensus estimates, analysts' revenue estimates for FY23 and FY24 have been cut by an average of 3-3.5%. ' earnings were downgraded by 2.62% in the last three months. Earnings per share (EPS) estimates of Infosys and were downgraded by 3.5% each during this period. and Tech Mahindra have seen EPS downgrades by 9% in three months.

IT stocks have corrected more than 25% on an average since the beginning of the year. Stocks such as Wipro, Tech Mahindra, L&T Infotech, , and Coforge have plunged more than 40% since January 1.

"Any US recession is bound to have some adverse impact on India's software exports at the margin," said Teresa John, analyst at Nirmal Bang Institutional Equities.

“In FY21, the US was the major destination for software exports, accounting for a 54.8% share.” The Nifty IT index has corrected 18% in the last six months, compared to a 3% gain in the Nifty index.

Some large-cap IT companies have delayed or reduced variable pay to employees owing to margin pressures. Operating profit margins for IT companies shrunk further in June 2022 and are now below pre-Covid levels for tier-1 companies in the sector. The companies had reduced their margin guidance at the start of FY23. Elevated attrition levels are likely to result in margins dropping near the lower end of guidance, said analysts.

“Tech demand has been impacted by fears of a likely recession in the US, high attrition, and margin pressure which are likely to impact sentiments further in the IT sector in the near-term,” said VK Vijayakumar, chief investment strategist at .