Infosys, TCS Q1 results set to disappoint investors; IT sector staring at flat sequential growth

The Indian IT sector is likely to report a subdued earnings performance in the fiscal first quarter Apr-Jun, with giants Infosys and TCS remaining flat, primarily due to a slower conversion of the deal pipeline, resulting in a decline in volumes during a seasonally strong quarter. “Infosys and TCS are expected to post flat sequential performances, and we expect Infosys to reduce the upper end of its FY24E growth guidance (from 4-7% to 4-6%),” HDFC Institutional Equities said in a research note.

Growth dispersion for the Indian IT sector will increase despite the aggregate slowdown, said the report. “We continue to build growth/demand normalisation in H2FY24E and a flat trajectory of margin in FY24E as compared to FY23. Our industry checks and high-frequency indicators point to no change in the demand environment in the last two months even as vertical-specific variability is likely to continue,” it added.

Growth trajectory to remain moderate

The brokerage report has reduced the IT sector’s earnings estimates by approximately 1% primarily due to a lower short-term growth trajectory valuations rollover to Jun-25E. The report predicts that the growth of the IT sector will moderate to 5% in FY24E but is expected to recover to 9% in FY25E. The mid-tier IT segment is likely to maintain a growth premium of more than 500 bps, which is also evident in the difference between the trend of earnings estimates for tier-1 IT (down 5% YTD) compared to mid-tier IT (which saw a 3% increase in EPS estimate).

“Nifty IT index valuations have fallen by 5% YTD,  while Accenture’s valuations are up by >10% YTD (which has historically  been highly correlated). IT sector valuations (at 21.5x) are between 5Y and 10Y averages and earnings are expected to grow at 11% CAGR over FY23- 25E,” said the report.

Infosys and TCS to remain flat while HCL Tech and LTIM may lead tier-1 IT

Within the tier-1 IT sector, Infosys and TCS are expected to reflect flat sequential performances, whereas Wipro and Tech Mahindra are expected to decline sequentially. The sequential growth however, will be led by HCL Tech and LTIM. In TCS, the margin decline is more pronounced while their operation performance is to remain steady. For Infosys, the report anticipated to reduce the upper end of its FY24E growth guidance (from 4-7% to 4-6%). The report further recommended taking a selective stance with a preference for  LTIMindtree within tier-1 IT.

“Mid-tier IT growth premium is expected to continue with sequential growth performance led by Tata Elxsi and Persistent Systems. The laggard in mid-tier IT will be Mphasis with an expectation of a sequential decline,” said the report. Persistent Systems is another company within the mid-tier IT, which remains attractive on a PEG basis.