IT stocks tumble as Credit Suisse warns of valuation-led correction

Indian IT valuations, the brokerage and research house argues, are at large premium to history despite material correction from the top

Shares of information technology (IT) companies slipped in trade on Friday after Credit Suisse warned of a 10 – 27 per cent valuation-led correction in these stocks amid US macro headwinds. The Nifty IT index lost over 3 per cent in intra-day trade with frontline stocks such as HCL Technologies (HCL Tech), Mphasis, Tech Mahindra and Infosys slipping between 3 per cent and 7 per cent.

Indian IT valuations, the brokerage and research house argued, are at large premium to history despite material correction from the top. Their analysis of six large correction cycles for the Indian IT sector suggests that barring a huge sudden macro event such as the global financial crisis (GFC) and Covid-19 pandemic, stock correction is driven mainly by valuation and not earnings per share (EPS). IT valuations, it said, are stretched by every measure, and that will drive a correction in these stocks if the US macro weakens.

“They (IT stocks) trade at 34 per cent premium to one-year pre-Covid average, unlike 11 per cent premium for Nifty and single-digit premium for S&P 500 and S&P IT. The top 4 Indian IT names could see large valuation correction as macro in the US weakens. We see HCL Tech at high risk of over 20 per cent valuation correction, around 15 per cent for Infosys and Wipro, and 8 per cent for TCS,” the Credit Suisse note said.

Among the lot, they remain bullish on Infosys, which is their only ‘Outperformer’-rated stock in the sector on superior growth prospects, and the possibility of a valuation catch-up with TCS.

That said, most IT stocks back home have been underperformers thus far in calendar year 2022 (CY22). The Nifty IT index has tumbled nearly 25 per cent year-to-date. In comparison, the Nifty50 index has moved up over 7 per cent during this period, ACE Equity data showed.

Those at Nomura, too, have been cautioning against the rich valuations of select Indian IT companies amid recessionary fears. For Indian IT services companies, they said, the pain is likely to be more pronounced for companies dealing with interest rate-sensitive sectors like mortgage, capital markets in the BFSI vertical, discretionary retail, and pockets of manufacturing verticals.

In the very near term, furloughs are likely to weigh on growth for the sector in the third quarter of fiscal 2022-23 (FY23), Nomura said in a recent note, and expects USD revenue growth to slow down from 12.7 per cent in FY23 to 8 per cent in FY24 for companies under their coverage.

“Companies with a lower discretionary portfolio (consulting) and exposure to Europe are likely to fare better than the rest. We expect the weakest revenue growth for TCS and the strongest for Infosys in FY24 among the large-caps. Our top picks in the sector are Infosys (in large-caps) and Persistent (in mid-caps). We maintain our Reduce rating for TCS,” wrote Abhishek Bhandari and Krish Beriwal of Nomura in a recent note on the sector.