Can Indian IT companies replicate the FY07-15 boom?
Since the anticipation of rate cuts began building up after December, the Nifty IT index has witnessed a significant rally of over 17.5% to date.
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However, the latest update from the Fed suggests that a rate cut is not likely to happen immediately (contrary to market expectations, which hoped for the first cut in March 2024), but it could occur gradually throughout the year.
Despite this, a comparison of the performance of Indian IT companies during FY07–15 with the current anticipated rate cut scenario indicates that these companies could potentially outperform Nasscom estimates in the medium term, as stated in the latest report by leading brokerage firm Systematix Institutional Research.
Strong correlation
The analysis by Systematix shows a strong correlation between the USD growth of the Indian IT industry, including the individual performances of the top four IT companies, and the Fed rate reversal cycle. Between FY07 and FY15, the Fed rates underwent moderation, followed by an ascent.
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During FY07–15, TCS and HCL Tech exhibited impressive outperformance with a CAGR of 18% and 19.9% in USD revenue growth, surpassing the IT industry’s 15.6% CAGR. Infosys and Wipro registered 13.8% and 13.5% CAGR, respectively, during this period.
On the earnings front, TCS recorded a 23% CAGR, while Infosys, HCL Tech, and Wipro achieved 15.6%, 23.3%, and 14.6% CAGR, respectively, during FY07–15.
The brokerage has pointed out that the growth was even stronger during the immediate 2-year rate cut cycle of FY07 and FY08, causing USD revenue in the IT industry to surpass 30% growth in FY07 and post 29% growth in FY08 before moderating in FY09 (impact of the global financial meltdown).
The brokerage stated that the Fed rate currently mirrors the FY07 level. Its analysis suggests that the expected reversal in the Fed rate cycle could favour IT companies, leading to strong revenue and earnings growth in the medium term, akin to FY07–15.
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“Although it is difficult to predict if the pattern would be similar this time (i.e. if the rate cut would be sharp in the immediate two years post-peak rate, causing revenue and earnings to bump up).”
“Even if the rate cut were to be gradually spread over 5–6 years, we do not rule out strong revenue and earnings growth for IT companies. When or where the rubber hits the road, we see the possibility of USD revenue growth in the industry outperforming the current Nasscom estimates (~9% CAGR in FY23 industry revenue of USD 245 billion, industry touching USD 500 billion by FY30) over the next 5–6 years,” it said
FY24 is weak, but recovery is likely from FY25 onwards
The December quarter performance (Q3FY24) of the top 5 players suggests likely weak revenue performance in FY24, after the strong growth these companies witnessed in FY22 and FY23.
According to the brokerage, Infosys, TCS, and HCL Tech are expected to report low single-digit growth in USD revenue, Wipro and Tech Mahindra may see their revenues decline in FY24.
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It says that the top 3 players may see revenue recovery from FY25 onwards, boosted by continued deal momentum, as reflected in their order win numbers. Moreover, a reversal is expected in spending by some of their clients from the US and Europe in the BFSI, retail, and telecom verticals, where spending has been muted due to cost pressures, it added.
Initiated coverage on the sector
The brokerage firm has initiated coverage on the sector, providing the following ratings:
TCS (Target Price: ₹4,575): BUY: Identified as a likely beneficiary of vendor consolidation opportunities and deemed to have attractive valuations.
Infosys (Target Price: ₹2,000): BUY: Positioned as a potential beneficiary of vendor consolidation opportunities, with a favorable valuation outlook.
HCL Tech (Target Price: ₹1,610): Positive Hold: Recognised as a likely beneficiary of vendor consolidation but cautioned against investment due to the recent expensive valuation post a substantial run-up.
Wipro (Target Price: ₹440): Negative Hold: Anticipated challenges in the near term due to leadership exits, placing pressure on growth. Valuations are considered expensive.
Tech Mahindra (Target Price: ₹1,095): SELL: The company may encounter short-term growth challenges from key clients, and its key vertical may require time for recovery.
Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before making any investment decisions.
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Published: 07 Feb 2024, 12:04 PM IST
