Nifty IT hits fresh 1-year low, all shares in red. Which stocks to buy/sell?

Nifty IT shed 1,334.60 points or 4.71% to end at 27,008.20. However, the index has dropped by at least 7.6% during the day. It touched a new 52-week low of 26,184.45.

After nosediving by nearly 15% in the day, Infosys stock ended at ₹1,259 apiece down by 9.37%. The second largest IT company in terms of market share, has also touched a fresh 52-week low of ₹1,185.30 apiece.

Further, LTI Mindtree followed with a drop of 7%, Tech Mahindra dipped by 5.2%, and Persistent Systems tumbled over 4.1%. Coforge also slipped by 3.3%. Infosys rivals like HCL Tech saw a 2.8% contraction, and Wipro and TCS shed around 1.8% and 1.6% respectively. Mphasis and L&T Technology Services were also down by 1.75% and 2.6% respectively.

In its latest report, Kotak Institutional Equities said, “TCS and Infosys’ earnings prints had two common factors (of course, Infosys was a shocker compared to TCS): (1) deterioration in demand from North America with discretionary programs that were paused or canceled and (2) an inability to flex margin levers as near-term costs are sticky at the beginning of the slowdown.”

Analysts here said, “Our structural view on margins and growth has not changed, even as we recognize elevated headwinds that could feed into multiples in the near term. Stocks to avoid are the ones trading at premium multiples after assuming elevated growth and margin assumptions.”

The common challenge between TCS and Infosys was the slowdown in the US market and it was sharper than expected. Infosys and TCS reported sequential revenue declines of 3.8% and 0.8%, respectively, in North America.

Kotak’s note said, “The revenue decline in North America was across verticals on a sequential basis. The reasons for the decline were a pause in discretionary programs and even cancellations. After a slow start in January, projects were paused/canceled in February and it continued in March.”

Further, the brokerage’s report added, “We would not be surprised by a weak US performance across companies that are likely to report in the coming days.”

After Infosys and TCS, the next in line to present their Q4 results are HCL Tech on April 20, followed by L&T Tech on April 26, while Tech Mahindra, Wipro, LTI Mindtree, and Mphasis on April 27.

Kotak has given a ‘Buy’ recommendation on three IT stocks:

HCL Technologies: Target price of ₹1,235 apiece.

Infosys: Despite near-term risks, the brokerage is still optimistic about Infosys shares and has set a target price of ₹1,470 apiece.

Rategain Travel Technologies: TP of ₹450 apiece.

But the brokerage gives an ‘Add’ rating on 3 IT stocks:

Mphasis: TP of ₹1,950

TCS: TP of ₹3,320

Tech Mahindra: TP of ₹1,200

While a “REDUCE” recommendation is given on LTI Mindtree and Wipro with a target price of ₹4,350 apiece and ₹370 apiece respectively.

Additionally, the brokerage gives a ‘Sell’ recommendation only on L&T Technology Services with a target price of ₹3,000 apiece.

According to Kotak, their valuations on IT stocks are based on a quick resolution to the global banking crisis and problems arising from banking industry events remaining localized to BFS. The brokerage does not assume a deep recession in its valuation base case.

The note said, “Increasing probability of recession does pose risks to multiples. Improved payout ratios of IT companies, full participation in digital journey of clients, and legs to medium-term growth from the completion of digital transformation journeys of clients mean that stocks could bottom at multiples higher than earlier recessions, assuming similar cost of equity as in the past. Stock valuations do not bake in a recession but do build in a slowdown.”

It added, “large-cap stocks are ~ 15% away from building in a recessionary scenario.”

Also, the brokerage highlighted that growth for IT services companies has been democratic in the last two years, as enterprises spent aggressively on digital journey. While digital spending will continue, a challenging environment will also force organizations to focus on costs. Higher focus on costs, especially by enterprises in the impacted verticals, should lead to various cost take-out opportunities. Some aspects such as optimizing costs of cloud and SaaS consumption is addressable by a wide variety of players.

Finally, Kotak’s note added, “TCS and Infosys are best positioned. HCLT and LTIM can benefit in select cases. Similar cost take-out opportunities, but among smaller enterprises may be addressable by a larger pool of companies. Many other companies in the space will struggle—growth between leaders and laggards should widen in FY2024 and beyond.”