Premiums for IT stocks may not last for long; BSE IT index up 3%

Positives already priced in despite triggers like US deal wins, rupee fall

Despite selling pressure across the market, the IT sector remained investors’ preferred choice (barring last two sessions), thanks to the weakening rupee. 

In the last one month till October 1, the BSE IT index increased about 3 per cent, as against a 5.5 per cent decline in the Sensex. 

At Wednesday’s closing, the sector traded at around 21 times its one-year forward earnings, which is a 30 per cent premium to its historical average valuation of 16 times. 

Among the top five IT companies, Tata Consultancy Services (TCS) is trading at about 27 times FY19 estimated earnings — the highest among IT companies. Tech Mahindra is the lowest at 16 times. 

However, the question is — will the sector continue to enjoy the premium?  After the recent surge, analysts believe that the rupee depreciation has already been factored in and there is little scope for further upgradation in stocks. The trigger for the sector is a better-than-expected performance in the September quarter (Q2).

Analysts expect IT companies to report a strong Q2. Analysts at Motilal Oswal Securities indicated that the second-quarter seasonal strength, coupled with the benefits from a favourable currency, is likely to drive a continued recovery for the technology sector. 

In fact, a 5.5 per cent fall in the rupee versus the dollar in Q2 will lead to margin expansion, mainly for the top companies. This, in turn, will boost their earnings.

The sector is expected to report a 6 per cent sequential rise in aggregate sales in Q2, and about 11 per cent in net profit. 

Many large-cap players like TCS, Infosys and HCL Technologies (HCL), among others, will report up to 7 per cent revenue growth.

Performance of the banking, financial services and insurance (BFSI) vertical is a key trigger for IT companies. 

The BFSI vertical is the largest contributor to revenues of companies such as TCS and Infosys, and is expected to do better. 

The worry for the BFSI segment is the performance of the European markets, where growth has been tepid. 

Accenture, for instance, recently reported a deterioration in financial services growth in the August quarter, due to an inability to replace some large programmes in European financial firms.