Q2 IT sector preview: PAT to remain muted; expect re-rating in near term

The impact of slow growth led by global headwinds is largely factored in the prices and investors are gradually changing their view

The information technology (IT) sector is now showing early signs of reduction in the extent of earnings downgrades. The sector went through a slew of downgrades led by muted revenues and profitability guidance due to a slowdown in the business model.

Though the IT industry is likely to remain muted for the entire financial year 2018 (FY18), earnings are expected to grow by 11 per cent year-on-year (YoY) in FY19. Outlining the industry’s annual guidance in June this year, Nasscom had said that the Indian IT exports would grow by 7-8 per cent in FY18, same as the previous fiscal year, while the domestic Infotech industry would expand at 10-11 per cent. 

Digital automation, cloud and other new technologies dented the outsourcing activities which led the industry outlook to remain bleak. Sill some tailwinds could bring relief to the sector. The slowdown in the economy has led the dollar to strengthen from its low of 63.6 to 65.5 (in the last 7 months), rupee is likely to maintain its moderate trend owing to government’s fiscal deficit overhaul and US Fed rate hike and balance sheet unwinding. 

We expect that the positive economic indicators from the US and Europe will allow the BFSI sector to stretch their discretionary spending on IT. Increase in trade ties with US in the field of defense and oil is expected to give room to re-negotiate for faster processing of H1B visa. 

Encouraging signs and change in consumer sentiments towards defensive sectors owing to slowdown in the economy and higher valuations in growth-oriented area can help IT to get a re-rating in the near-term. The impact of slow growth led by global headwinds is largely factored in the price and investors are gradually changing their view, expecting to reap the benefit in the long haul. 

For Q2FY18, the market expects revenues to grow by 4 per cent. However, profit after tax (PAT) growth is expected to remain muted on a YoY basis. Margin is expected to reduce by 40 bps on a YoY basis. Historically, the average price to earnings (PE) ratio of IT index has been 16x during the last five years, while currently it is trading at 15x in which TCS and Infosys is valued at 16x and 15x, respectively.

The author is head of research at Geojit Financial Services. The views expressed are his own.

Disclaimer: Views expressed are personal. They do not reflect the view/s of Business Standard.