IT Sector Thematic Report - Demand recovery in sight - HDFC Securities

Mr. Apurva Prasad and Mr. Amit Chandra, Institutional Research Analyst, HDFC Securities.

Indian IT: Demand recovery in sight

Indian IT is expected to recover 2Q-3QFY21 onwards. While the severity of the economic impact has been reasonably factored, the trajectory of recovery is uncertain. We expect the demand trajectory to rebound sharply based on our top-down industry scenario analysis, primary checks, resilient dynamics in core verticals and strong digital playbook.

Our checks with IT cos./industry experts suggest (1) Scale & end-to-end services suite (increasing partner-led deals) are strong factors for vendor consolidation gains (pricing, large deal constructs & existing customers CSAT key elements) as enterprises undertake technology portfolio rationalisation, (2) Reduction in legacy tech estate of enterprises to gather pace post-covid and higher share of F-500 customers provide resilience, (3) Accelerated automation and higher work from home are expected to impact service delivery in the long term with changes in talent practice, and (4) Higher near-term impact on account of delay/cancellation in discretionary projects, as compared to impact from pricing/volume cuts in business critical projects with overall tech budget cuts in 5-15% range.

Market-share gains across cycles: Indian IT (even Wipro) has delivered a consistent track record of market-share gains vs. global IT, across tech mega trends and market cycles, which reflect the strong competitive advantage (recent growth outperformance by ~700bps). Contrary to popular narrative, Indian IT's growth in the digital/cloud era (FY15-20) has outpaced global IT peers (>80% share of incremental growth within large global IT), following significant gains in the post GFC period. Portfolio depth across verticals & technologies underpins our expectations of continued outperformance.

Favourable risk-reward: Key observations from top-down industry scenarios analysis suggest (1) Favourable risk-reward for the sector as even a bear case implies recovery beyond FY21 and as cyclical downtrend in a structurally positive outcome has limited impact on valuations, (2) Bear case & bull case implies a rev growth variance of ~10% in FY21 (-12% YoY to +1% YoY range) and ~6% in FY22 (+6.5% YoY to +13.5% YoY range) for tier-1 IT, (3) HCLT has the least impact in bear case and highest upside in a bull case (supported by acquisitive growth), and 3) TCS and Infosys exhibit fairly similar levels of sensitivity under bear-bull case.

Resilient dynamics of verticals & strong digital playbook: Vertical trends suggest (1) BFSI tech spend buoyancy despite slowdown, (2) Recent recovery in US retail concurrent with tech spend priorities such as building omni-channel & in-store analytics (strong recent deal activity in HCLT/TCS), 3) Positive enterprise trends in Healthcare vertical (HCLT/Wipro higher exposure) in conjunction with tech investments in RPA.

Maintain constructive stance: Despite the strong valuations re-rating to pre-covid levels, 1) IT valuations are at historical avg. (-8% below +1SD), 2) Valuation skew within the sector provides opportunities, and 3) USD-INR has upside risks (revised EPS higher ~4% factoring USD-INR at 75/76 for FY21E/22E and our target valuations are revised upwards to historical avg. on better visibility). Upgrades include Wipro (ADD) and Mphasis (BUY); downgrades include L&T Tech (REDUCE) and Hexaware (REDUCE).

Source : Equity Bulls

Keywords