Indian IT companies to see a re-rating similar to FAANG stocks: Edelweiss

Information technology (IT) stocks have been on the investors' radar in the calendar year 2020 (CY20) as a safe haven bet at a time when the economic activity came to a near halt due to the Covid-19 pandemic and the subsequent lockdown to stem the spread of the virus. Thus far in CY20, the Nifty IT index has risen 15.5 per cent as compared to over 5 per cent decline in the benchmark Nifty50 index.

Analysts see more headroom for the IT stocks over the next few quarters. According to Edelweiss Securities, IT stocks are trading at a 40-60 per cent discount to their fair value and global peers, and this anomaly in valuation is likely to correct over the next three-four years.

"Digital revenues and growth rates of Indian biggies such as TCS, Infosys, and HCL Technologies are superior to global peers such as EPAM and Luxoft; yet they are trading at 20–60 per cent discounts to their fair value and a 50 per cent discount to these global companies. This anomaly in valuation, we argue, would correct as the digital wave builds up into a storm over the next three-four years and would effect a seminal change in investor perception," wrote Sandip Agarwal, an analyst with Edelweiss Securities in a co-authored note with Pranav Kshatriya.

The brokerage further says that its in-depth analysis indicates a jump in earnings at a compound annual growth rate (CAGR) of 17-19 per cent over FY22–25 from 6-12 per cent over FY18–21, implying an uptick of at least 1.5 times in trading multiples—similar to that for the FAANGs ecosystem.

"All in all, we strongly contend that a substantial re-rating driven by multiple earnings upgrades and higher price/earnings to growth (PEG) ratios—similar to what happened in FAANGs’ ecosystem—is in order," it said. FAANG stands for Facebook, Amazon, Apple, Netflix and Alphabet (formerly Google).

Among Nifty IT constituents, Mindtree has gained the most - up nearly 50 per cent year-to-date (YTD), followed by L&T Infotech, Infosys, Mphasis, and HCL Technologies, ACE Equity data show. (See table below)

Structural shift

Edelweiss believes that the digital growth wave in India is building into a storm and signalling stellar growth prospects for IT companies.  

"We believe the Covid-19 pandemic has accelerated the demand for hi-tech by shrinking the human activity into a world of apps—and in many ways efficiently so. The explosion in online activity has galvanised massive cloud-led adoption, digital adoption, and transformation of the core. Global digital penetration has been reset at lower levels in light of emerging realities, thereby resetting the high-growth phase for technology from FY24 to up to FY27 in the least, " analysts at the brokerage firm wrote in a report dated September 2.

That apart, structural cost savings from rising adoption of work-from-anywhere (WFA) would also significantly aid the earnings of the companies. "Those structural cost savings from rising adoption of work-from-anywhere (WFA) on the back of reduction in travel cost, lower wages for talent in tier 3–4 towns, lower capital expenditure (capex) and resultant depreciation would follow are of no less significance and can power companies on their own standing—and our realistic optimism on the space."

The brokerage has raised the target price of Indian IT stocks under its coverage by up to 80 per cent. Among large-caps, HCL Tech, Infosys, TCS, and Tech Mahindra are its top picks while in the mid-cap segment, it prefers Mindtree, L&T Technology Services, and Larsen & Toubro Infotech. It is bullish on Eclerx, Cyient, and Persistent in the small-cap space.

POISED FOR FURTHER UPSIDE
	Closing price (Rs) *	Change (%) ^
Mindtree	1194.15	49.24
Larsen & Toubro Infotech	2479.2	41.63
Info Edge (India)	3473.75	37.30
Infosys	924	26.38
Mphasis	1144.85	24.14
HCL Technologies	701.95	23.56
Coforge	1945.95	22.40
NIFTY IT	18077	15.49
Wipro	273.7	11.35
Tata Consultancy Services	2265.15	4.79
Tech Mahindra	735.2	-3.56
NIFTY 50	11535	-5.21
Closing price as on September 2, 2020
^ Change is YTD; Data source: ACE Equity