High attrition, employee cost casts spell on IT stks; buy on dips: Analysts

Information technology (IT) sector stocks have been on a downward spiral thus far in 2022 with the Nifty IT index slipping over 7 per cent on the NSE, underperforming the benchmark Nifty50 index that has moved up over 2 per cent during this period. The index has been the worst hit amongst its peers on the NSE. 

The nervousness in the IT stocks, analysts believe, is on account of rising employee costs at a time the business growth has been modest year-on-year in the December 2021 quarter (Q3FY22).

“High attrition and high employee costs are taking a toll on large IT companies. Companies such as TCS have spent nearly a large chunk of their money on employees. That apart, revenue growth in dollar terms has been modest. Had the growth been in double digits, the rise in employee costs would not have been a cause for concern. In this backdrop, the underperformance of large IT stocks is likely to continue,” said G Chokkalingam, founder and chief investment officer at Equinomics Research.

Hiring momentum in IT services companies, analysts believe, is expected to continue in CY22 as well. TCS has added 77,000 freshers in the first nine months of FY22 (9MFY22). On the other hand, Infosys has revised total fresher hiring target for FY22 to 55,000 from earlier 45,000 (up for the third consecutive quarter), and Accenture has done net addition of record 105000 employees in H2CY21, with majority of new hires from India, reports suggest.

Employee costs in IT sector. Source: Equinomics Research

“The surge in demand for talent is increasing lateral hiring costs of Indian IT companies. We estimate that employee costs for IT firms in our coverage universe are expected to increase by Rs 645/548/569 billion per year for FY22/23/24E (2x of last 6-year average),” wrote Amnish Aggarwal of Prabhudas Lilladher in a recent coauthored report with Anushka Chhajed.

The fall in IT stocks over the past few weeks back home is also in line with the slide in tech-heavy NASDAQ that has lost nearly 8 per cent thus far in CY22. Analysts believe the concerns on the monetary policy tightening in the months ahead are weighing heavily on tech companies that are yet to show revenue and profit growth.

“Concerns are rising on Fed tightening, which has been weighing on the profitless tech names. We have already seen FANGMAN stocks (Facebook, Apple, NVIDIA, Google, Microsoft, Amazon, and Netflix) down 10-30 per cent in the past one month. This is visible in emerging markets (EMs) as well. China is also down sharply from the peak, due to regulatory concerns, but many names have moved up recently. Despite the correction, the fundamental growth story is intact and we expect steady share gains for online players across a range of industries. For investors with long-term outlook, we see correction as an opportunity to Buy,” wrote analysts at Jefferies in a recent note.

Back home, Chokkalingam believes the mid-cap IT companies still hold promise and investors can use the fall in these stocks to accumulate from a medium-to-long term horizon.

“Investors should focus on the mid-cap IT players where the consolidation process is still not complete. Among the lot, investors can look at TCS as it has been able to manage attrition very well. I am also bullish on Cyient. We recently gave a sell call on HCL Tech,” he said.

Those at Prabhudas Lilladher maintain overweight (60bps) on the IT sector in their portfolio with focus on Infosys, TCS, Tech Mahindra and Wipro. “The sector is in for strong growth in coming years, although a near-term pause post sharp moves of the past few quarters looks likely. We increase weightage on TCS by 100bps given strong visibility and Rs 18,000 crore buyback," Aggarwal and Chhajed wrote.

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