Wipro, Tech Mahindra: Jefferies downgrades six IT stocks on recession fears

Earlier in May, analysts at JP Morgan had downgraded the Indian IT sector citing growth concerns. Rising margin headwind in the near-term, JP Morgan had said then, was one of the key concerns.

The possibility of a recession in the US has made analysts cautious on the information technology (IT) pack, with those at Jefferies downgrading six large-and mid-cap companies. The list includes Tech Mahindra (Tech M), HCL Technologies (HCL Tech), Wipro, Coforge, Larsen & Toubro Infotech and Mindtree.

“Revenue growth for Indian IT firms is likely to moderate sharply by 340 basis points (bps) due to a recession in the US in fiscal 2023-24 (FY24). We lower our revenue and earnings per share (EPS) estimates by up to 15 per cent to factor this and expect earnings cuts to drive further price-earnings (PE) derating for IT stocks,” wrote Akshat Agarwal and Ankur Pant of Jefferies in a recent coauthored note. CLICK HERE FOR REVISED EPS ESTIMATES

Infosys is Jefferies’ top pick with a price target of Rs 1,700 given its sector-leading growth and strong execution. TCS, it said, is better placed among the lot, and the brokerage has maintained a ‘hold’ rating on the stock despite rich valuations. However, TCS' rating came ahead of the June quarter numbers that were announced post-market hours on Friday.

“We downgrade HCL Tech to ‘hold’ given its higher exposure to ER&D and products business; downgrade TechM to ‘hold’ as it is likely to witness the sharpest earnings cuts due to slippage in margins. We downgrade Coforge to underperform as its large number of sub-$1 million relationships add risks to growth,” Agarwal and Pant wrote.

On the other hand, Wipro, Jefferies said, was downgraded underperform due to risks of higher consulting exposure and slippage in margins due to acquisitions. While Larsen & Toubro Infotech's revenue mix is better versus the other mid-sized firms, Jefferies believes the integration risks with Mindtree amidst a recession are a concern. Hence, the brokerage has downgraded the stock to underperform.

In a recessionary environment, clients, Jeffeies believes, may fund their transformation programs by lowering discretionary spends, increasing large outsourcing deals and potentially consolidating IT vendors. In this context, TCS/Infosys, Jefferies said, are better placed while Mindtree/Coforge are the worst placed.

Earlier in May, analysts at JP Morgan had downgraded the Indian IT sector citing growth concerns. Rising margin headwinds in the near-term and revenue headwinds in the medium-term, JP Morgan had said, posed a challenge for the Indian IT sector.

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“We see peak revenue growth behind us and earnings before interest and taxes (EBIT) margins trending down from inflation, mean revision. While the bottom-up outlook remains for most Services, Software, and SaaS names YTD, and the tech spending cycle remains buoyant structurally, we feel there are more downside risks to the current earnings assumptions. This leads us to downgrade our sector stance to underweight and target multiples by 10 – 20 per cent driving TCS, Wipro, HCL Tech, L&T Technology to underweight from neutral,” wrote Ankur Rudra and Bhavik Mehta of JP Morgan in the May report.

Thus far in calendar year 2022 (CY22), IT stocks have taken a beating with the Nifty IT index slipping 27 per cent as compared to the Nifty50, which has lost around 6 per cent during this period on global recession fears, ACE Equity data show. The cuts in some of the individual stocks have been sharper CYTD with Wipro, TechM and TCS falling up 12 per cent to 41 per cent.

That said, while a sharp moderation in growth is almost certain in FY24, analysts at Jefferies believe that this recession is different in two ways. 

"First, clients are undergoing large-scale tech transformation which might not be abruptly stopped. Given this, growth in global IT spends might remain above trend-rate beyond FY24. Second, Indian IT companies have emerged as strong transformation partners while maintaining their cost leadership, which should impact them less verus their global counterparts," Jefferies said.