IT Services Sector Shows Signs of Recovery: Experts Weigh In on Future Prospects

Mint Primer | IT services: When will the tide turn?

With a mixed performance in Q1 FY25, the $250-billion IT services industry is not entirely out of the woods. Discretionary spending is yet to return, and AI is taking time to convert from proof of concept to meaningful large projects. Mint explains the sector's outlook. The IT services sector continues to navigate an unpredictable path. Q1 for TCS, Wipro, HCLTech, Infosys and LTIMindtree was a mixed bag: key metrics were either flat or saw marginal improvement. For TCS, Ebit margin or the operating margin narrowed to 24.7% from 26% in the previous quarter. Total contract value at $8.3 billion, fell both year-on-year and sequentially. HCLTech and Wipro revenues fell sequentially, though profit grew, while LTIMindtree's profit fell 1.5% y-o-y. Infosys reported better-than expected numbers with net profit up 7.1% y-o-y and raised revenue guidance for FY25 to 3-4% from 1.5- 2% earlier. Leaders across companies believe this fiscal will be better than the previous one. However, global IT spending continues to be cautious. According to Gartner, worldwide IT spending is expected to total $5.26 trillion in 2024, an increase of 7.5% from 2023. But this is a decrease from the previous quarter's forecast of 8% growth. Contract backlogs going back to the third quarter of 2023 are being cleared only now, and there will be a larger rush towards the end of the year to make up for the slow start. This means Q2 could also see muted growth, before spending picks up in the second half of this financial year. Some verticals are seeing spends being conservative, impacting overall growth as banks are unwilling to open up the purse strings till there's clarity on interest rate reduction. Banking, financial services and insurance, accounting for 30-40% of TCS' revenue, declined marginally. Consumer, technology services, and communication and media saw muted growth. Spending on Generative AI (GenAI) is yet to pick up, delaying recovery for the sector. There are a lot of proof of concept (PoC) projects in GenAI, but they are yet to translate into deals for IT services firms. The big spending will come as customers move from PoCs to large projects. Last month, Accenture, the world's largest technology services firm, reported $2 billion in GenAI deals for the first nine months of the company's fiscal year. Indian players are still firming up their AI strategies and do not report AI wins separately. The second half may see a turnaround, with the return of spending and AI-led projects. Note, however, that customers are leaning on cost cutting strategies including vendor consolidation. Companies are seeing customers tweaking contracts amid global uncertainty. Interestingly, the last 12 months have seen a rise in global capability centres (GCCs) or in-house IT sourcing centres as well. While this is good for local job creation and the sector, it could impact the work that goes to third party providers.

Nifty IT up 24% in 2 months; is the worst behind for the sector? What should investors do? Here's what 5 top experts say | Stock Market News

The Nifty IT index has gained nearly 24 per cent since June. In contrast, Nifty 50 has gained over 8 per cent in the same period. IT stocks have been witnessing decent traction since June this year. The Nifty IT index has gained nearly 24 per cent since June. In contrast, Nifty 50 has gained over 8 per cent in the same period. On the monthly scale, Nifty IT gained an 11 per cent in July so far, following an almost 12 per cent gain in June. On the other hand, the Nifty 50 rose nearly 7 per cent in June and is up about 2 per cent till July 24. The recent gains in IT stocks could be largely attributed to optimism about rate cuts in the US with easing inflation. Most IT companies reported healthy numbers for the April-June quarter (Q1FY25), influencing investors. Are green shoots emerging in the sector, and should investors start betting on IT stocks? Should they prefer only large players from the sector? We spoke to five experts to get their insights on the IT sector. Here's what they said: On the attrition front, all IT companies reported a decline as the job market has cooled from the heydays of the post-pandemic years. However, fresh hiring has not picked up significantly so far. Most companies reported a decent quarter on the total contract value (TCV) metric. The management of IT companies desisted from commenting on estimated recovery timelines in discretionary spending. In Q1FY25, green shoots were visible across these companies in the BFSI space, especially in North America. Some IT companies believe that FY25 will be stronger than FY24 for them. The first quarter results (Q1FY25) of Indian IT services hint towards better fiscal growth than the preceding year, but there is still some time for the industry to be firing on all cylinders. Investors can stop being bearish on the sector and stocks. But they have to realise that a steady uptrend could take some time to begin once better indications of demand are available. Till that time, the stock prices could remain in a range. Large-cap IT stocks will provide a margin of safety. In contrast, small/midcap IT companies can provide faster upmove if they can show exceptional growth in a quarter due to their niche competencies, though carrying higher risk. The fortunes of the IT sector hinge primarily on the economic scenario and IT spending in the USA, as the bulk of the revenues generated originate from the USA and Europe. Given that many IT stocks, such as Coforge, Infosys, Mphasis, Persistent and TCS, to name a few, have generated superior returns in July itself, investors should look at booking part profit, given that markets could witness enhanced volatility in the coming weeks and months. Further, it makes sense to stick to large caps as, in the eventuality of any correction, the fall will be sharper in the midcap and the small-cap segments. We believe the BFSI vertical would lead to a revival in IT performance as companies drive up their technology spending plans on strong financial performance. Also, most companies have developed their offerings in emerging technologies and optimised their hiring and resource utilisation metrics. With most of the negatives seemingly priced in, we believe the risk-reward is favourable for accumulating IT companies from a medium to long-term perspective. Our preference is tilted towards large-cap IT names such as Infosys and TCS because of their wider product bandwidth, large and varied deal pipeline, ability to take cost-cuts, and attractive valuations. Given these results, we believe the most challenging period is behind us, as inflationary pressure is forecast to moderate in the US. The sector's outlook is positive, bolstered by potential interest rate cuts in the US, which will lead to improvement in spending. The Indian IT companies are focusing on improving operating profits by cost optimisation measures with strong traction in deal wins. Overall, our stance remains positive for the sector in the future. Although current valuations are premium compared to the five-year average forward PE, recovery signs in BFSI and the emergence of AI (artificial intelligence) and generative AI are the future revenue visibility, supporting continued investment in the IT sector. Large-cap IT companies delivered better-than-expected results in Q1, showing improvements in margins, whereas mid-caps have missed the earnings estimate with expensive valuations compared to large-caps. Therefore, large-cap stocks present a more favourable investment option. A stock-to-stock approach is preferable in midcaps with companies focused on ER&D, Auto-EV, healthcare, etc. Leading firms like TCS, Infosys, and HCL Technologies have exceeded market expectations, indicating robust performance and sequential growth across major markets. Despite profit and margin pressures, revenue growth remains strong, showcasing the sector's potential. The Nifty IT index has shown significant momentum, surging over 24 per cent since June 2024 and reaching a new all-time high in July 2024. This positive trend reflects increased investor confidence during market uncertainty, particularly in defensive sectors like IT and FMCG. Large-cap IT companies remain relatively undervalued and continue to show favourable market sentiments. The current environment makes it a suitable time for strategic investment in these companies. Read all market-related news here