Analysts expect turnaround for IT firms with growth recovery, higher margin

In previews of Q2FY25 and beyond, industry analysts are expecting a turnaround for IT services. High teens earnings per share or EPS growth is expected for the next 2-3 financial years. The hopes are backed by deal wins of above $100 billion as at Q1FY25, up 16.6 per cent Y-o-Y.

Margins seem to have stabilised. There are medium to long-term opportunities in digital transformation (DT), especially in Cloud, cybersecurity and GenAI. Positive sentiment from possible Fed cuts could accelerate demand.

While revenue growth for the companies represented in Nifty IT Index could be at an annual rate of 8.5 per cent over FY24-27, EPS growth may rise to 17.5 per cent over the same period, according to a report by Nirmal Bang Research. This is due to margin expansion, pyramid rationalisation, reduced subcontractor expenses, higher utilisation, and organisational changes, including CEO replacements.

On the macroeconomic front, a 50-75 basis points Fed rate cut in CY24 could improve client sentiment. Early signs of recovery are visible in the banking financial services and insurance or the BFSI sector. Hyperscaler revenues are also picking up faster. GenAI adoption may drive the next phase of growth in digital transformation.

The Nifty IT growth rate over FY19-22 was at 10 per cent for revenues and 12.3 per cent for EPS vs 5.5 per cent for revenues and 9 per cent for estimated EPS growth over FY22-25E. Higher deal flows could also mean reratings with higher target price to earnings multiples.

Global IT spending is expected to surpass $8 trillion by 2030, driven by investments in cloud, cybersecurity, AI, and automation. Cloud spending, particularly public cloud services, will be a major driver, supported by the rise of GenAI. Public cloud services are projected to grow by 20 per cent, reaching $678.8 billion, with Infrastructure-as-a-Service (IaaS) and Platform-as-a-Service (PaaS) both growing at over 20 per cent. Global cybersecurity spending is expected to rise by 11.4 per cent annually to $315 billion by 2028. GenAI is anticipated to impact budgets starting in 2025.

The outsourcing share of total IT spending (currently 10 per cent) will rise to 12.5-15 per cent by CY30. India, with more competitive hourly rates, is positioned to capture a larger share of this outsourcing growing aggregate share from the current 45 per cent to 55 per cent by CY30. This represents an opportunity of $550-600 billion at least by CY30.

After underperformance in CY22, and CY23, the Nifty IT Index is up 12 per cent in YTD CY24. The outlook for Indian IT services looks favourable. The Fed monetary policy appears to have reduced inflation while keeping unemployment low. The BFSI clients are set to increase IT budgets, while high-tech segments are investing in data infrastructure driven by AI and Internet of Things. Life sciences and energy utilities are also significantly invested in IT. Euro spending on IT is also likely to see a 9.3 per cent increase in CY24 and a 5-year growth of 5.3 per cent, driven by cloud-centric solutions, AI, and outsourcing.

There could be a spike in growth in FY26, driven by pent-up demand. The focus on GenAI and the productivity gains from it may lead to some revenue inflation. The IT industry accounted for 7.5 per cent of India’s GDP in FY23, and will contribute 10 per cent to GDP by FY27-28.

Given GDP at around $5 trillion by 2028, that implies IT revenue at $550-600 billion ($250 billion in CY23). The Nifty IT index has a 5-year mean valuation of PE at 30 times. Given better margins, that could turn into big returns, if the valuations are maintained or improved.