End of bull run for IT stocks, says Citi

If a report released by Citi Research is to be believed, run-up in IT services stocks is nearing its end.

The strong outperformance of nearly 45% over the last two years as compared to the broad market makes these companies fully valued on a relative basis.

The sector currently trades at 18.5 times their one-year forward earning numbers. The last time such a valuation was given to the IT sector was when the top four companies were growing at around 25% as compared to 10-15% in the current scenario.

 

With the markets touching new highs in an environment of optimism, analysts have been coming out with bullish reports.But bucking the trend, Citi Research has taken a contrarian view and has done a reality check on how much the stocks have run up compared to their historic valuations.

 

Following the release of Citi's report, CNX IT index saw a fall of over 3.25%.A total of 76 IT stocks are trading lower as compared to their previous day’s level.

 

Surendra Goyal and Rishi Iyer of Citi Research in their report titled ‘Indian IT Services Take a Breather – Positives priced in?’ argue that the general improvement in the macro economic environment is not translating to revenue acceleration in the IT services landscape. This could be due to commoditization in some of the traditional IT service lines.  Among the other reasons cited are high market share in the applications business and Cloud/SaaS impacting enterprise solution business.

 

Growth of Indian IT sector has slowed over the years from 35 per cent between FY02-06, 25 per cent between FY07-11 and 13 per cent between FY12-15 (estimated). Current valuations which are at those levels when the sector was growing at 25 per cent offers relatively low margin of safety.

 

Citi however, feels that the industry can still grow at low double digits due to growth from new markets like continental Europe, newer technologies (analytics, mobility etc.) and also gain from lower penetration in relatively new services lines including BPO/ITO. The research firm feels that there are considerable consulting and change management opportunities in the market.

 

Citi’s recommendation comes just days before Infosys announces its results. On Infosys, Citi sees risky volatility ahead on account of a 10 per cent relative outperformance and a 15 per cent run up in the stock over the last three months.

 

Domestic broking firms Karvy and Spark Capital have also timed their report along with Citi, but both of them are bullish on Indian IT sector. Karvy which has initiated coverage on the IT sector with a positive view feels that Indian IT firms are currently in an environment of healthy revenue growth, led by US discretionary spend and Europe cost-cutting led growth. Spark Capital on the other hand says that the rerating in the sector would sustain for large-caps and there is room for expansion of P/E ratio for companies such as Wipro and Infosys. Demand environment remains strong and scope for FY16E revenue upgrade do exist.