Shares of information technology (IT) services companies fell on Friday, after analysts said the industry’s growth momentum faces headwinds in the form of weakening macro indicators. The Nifty IT index fell 2 per cent, the most in a month. In comparison, the benchmark Nifty fell less than half a per cent.
All the 10 components of the Nifty IT index ended with losses, with industry leaders Infosys and Tata Consultancy Services (TCS) leading the decline. Infosys fell as much as 4 per cent, while TCS fell nearly 3 per cent before recouping some of the losses.
“We already see signs of year-on-year (YoY) growth moderation in the past two quarters. The trend is likely to accelerate, as weak macro translates into slower demand, ongoing pressure on the higher legacy business (about 65 per cent of revenue), and the benefits from large deals (lumpy in nature) wane in coming quarters,” wrote Nomura in a note on Thursday.
The brokerage said signals from the United States (US) — the biggest market for domestic IT companies — aren’t encouraging. “We see further weakening of the macro indicators in the US, with Street GDP forecasts moderating, CEO confidence at a 3-year low, services PMI below 50, and manufacturing PMI showing deceleration signs lately.”
Nomura said that even Europe — which is another key market — is showing signs of weakening.
The brokerage said barring a few verticals such as the US banking and financial services (BFS), consumer and healthcare, all other verticals are showing moderation in IT spends.
“Retail growth and profitability are impacted by structural issues at store retailers. Oil and gas, after two years of strong momentum, is seeing weakness due to lower crude oil prices. BFS Europe and capital markets are impacted by the macro, Brexit risks and falling interest rate environment. Within manufacturing, hi-tech and aero sectors have seen a sharp deceleration lately and auto continues to be impacted by the US-China trade war concerns and Brexit,” the brokerage said. While growth is slowing, there is little valuation comfort as the IT pack trades at a premium to its long-term average, indicating scope for moderation in stock prices.
“Tier-1 IT currently trades at 19.3x one-year forward earnings (our estimate), and is at an 8 per cent premium to its five-year average. We think valuations are not cheap, given the slowing YoY revenue growth and moderating margin profile,” said the brokerage. In 2019, the IT index has underperformed the benchmark Nifty, with the former gaining 3.5 per cent and the Nifty advancing 10 per cent.
Other defensive sectors such as FMCG and pharma have underperformed the IT index this year.
IT stocks currently trade at a 7 per cent discount to Nifty. Historically, they have traded at a 2 per cent premium to the benchmark index. When compared to other defensive sectors, IT trades in line with historical discounts to FMCG and lower discounts to pharma.