Earnings season | IT sector outlook: For IT, FY25 may turn out to be almost a déjà vu of FY24: Ankur Rudra, JP Morgan

Ankur Rudra, Head of APAC Telecoms & India TMT Research, JPMorgan, says there have always been hope rallies that have played in the IT services sector in the last year. We have seen some of that potentially play out in the last one-and-a-half months. But in the near term, we are not seeing any improvement in visibility. In the medium to longer term, one can be more optimistic, especially if you look at three to five years. But over the next year, the visibility remains clouded.

Are we in for more of the same this earning season or could there be a track change?
Ankur Rudra: I think the Indian IT result season this time is very interesting because we have a few mixed trends. We are looking at a backdrop of relatively weak tech services spending. We are looking at a backdrop of a lot of challenges that the sector faces in terms of client decision-making being relatively soft in the context of a weak macro, in the context of potential headwinds from generative AI crowding out spending.

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So, this year, while in Q1, for the sector, we would expect some sort of sequential growth improvement across the board, but that will be relatively muted versus other seasonal periods. Also, we will not get a significant improvement in visibility for FY25. As we enter the results season with the names that are reporting this week and next, we will probably have selective companies providing relatively stronger numbers partly because of certain deals that are ramping up, but on a sector-wide basis, we are not expecting a change in the level of clouding on the visibility that has been in the space for the last three to four quarters.

But what about FY26? In FY25, we are in for a single-digit growth, maybe 3% to 5% but is it realistic to expect a double-digit growth in FY26? Is that what you are penciling in?
Ankur Rudra: FY25 is turning out to be almost a déjà vu of FY24. We will barely see any improvement across the sector. Last year, growth was, like you said, low to mid-single digits. This year growth will again be low to mid-single digits. FY26, at the moment the visibility is relatively weak. Companies do not have visibility. Most of our conversations with either companies or with CIO teams suggest that fiscal 26 is a bit too far for people to look out for.

If anything, expecting double-digit growth for the sector is probably a bit too optimistic. We would expect at the end of the results season, some of the existing double-digit growth expectations, at least for the larger companies, should be moderated. We might see some of the smaller companies that are growing faster this year as well outshoot and so there will be dispersion and diversity in performance. But at least for the larger names, we would be very surprised to come out with any kind of conviction on double-digit growth for next year.

What about stocks commanding PE multiples north of 15 to 20 times one year forward if the growth next year also is not expected to be double-digit?
Ankur Rudra: Yes, the multiple is interesting. Of course, this is one sector that has seen an element of rally. So, if you look at the last one-and-a-half months, IT has recovered while it has underperformed for a longer duration. If you look at the last year-to-date or the last year, IT has underperformed the Nifty. For the last one-and-a-half months, IT has recovered somewhat. We do not think this is necessary because people are getting more optimistic on a bottom-up basis.
We think this is a bit more under-positioning-led rally. This sector has underperformed for a long time. The market is relatively rich and in that context, this is something that investors are chasing to an extent. Now, in the context of where the sector is, if you break the sector up into larger firms and smaller firms, there are sections of some of the larger firms where one might see an element of protection from either strong buybacks or dividend payouts, I think that supports a relatively higher multiple now versus prior periods, especially if you compare this to pre-COVID.

In some of the smaller firms, we are seeing an element of outperformance in sections of the sector. For example, the ER&D services firms are growing a lot faster. There are some of the growth heroes within the midcap IT space that can grow significantly faster and hence, potentially a stronger multiple is justified. But on an overall basis, we would be surprised to see these sorts of multiples sustained. I think parts of the market can sustain these multiples.

I look at commodity companies. When I see their numbers, they can give you predictability for three or four quarters. I look at IT companies, they struggle to give me predictability for the next quarter. My point is that these PE multiples which are sustaining, do you think it is a matter of time before there would be a secular derating then eventually?
Ankur Rudra: So, what we have seen in IT services overall, these are relatively sticky businesses. These are global cyclicals. And these companies are playing on enterprise technology spending. So, in a way, it is a function of how the business and technology cycle evolves. Visibility has been particularly weak in the last year or so, I think that sort of continues. So, those trends continue. So, multiples reflect, the level of quality one might see in parts of the market, it reflects what people might expect from a recovery potential. There have always been hope rallies that have played in the IT services sector in the last year. We have seen some of that potentially play out in the last one-and-a-half months. But in the near term, we are not seeing any improvement in visibility. In the medium to longer term, one can be more optimistic, especially if you look at three to five years. But over the next year, the visibility remains clouded.

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