IT stocks: Sector rotation, demand recovery hopes may support; Infosys, Wipro, Cyient among Emkay Global’s top picks

The Nifty IT index jumped more than 8% last week led by a rally in Wipro, Infosys, Tech Mahindra, Coforge, Persistent Systems and LTIMindtree shares that gained over 3-4% each. The index showed a significant outperformance over broader indices.

Gains in IT stocks came on the back of portfolio shift after the election outcome, increased hopes of interest rate cut by the US Federal Reserve, particularly after the rate cut announcements by Bank of Canada and European Central Bank (ECB) and relative valuation, analysts said.

The CME’s FedWatch tool, based on futures prices, puts around 50% odds on at least one rate cut by the Fed’s September meeting.

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Dipeshkumar Mehta, Senior Research Analyst at Emkay Global Financial Services believes the start of the interest rate-cut cycle would act as a signaling trigger for clients of Indian IT companies gaining confidence on inflation trajectory and macro stability, which may drive demand recovery and an uptick in discretionary spending. 

“Uncertainty around the inflation trajectory weighed on client decision making and revival in discretionary spending, with a full-fledged demand recovery now expected only in CY25/FY26,” Mehta said.

While the macro uncertainties continue with mixed economic data from the US, the demand environment for the IT companies also remains challenging. However, analysts at Emkay Global believe the near-term material change is unlikely.

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“There is no material change in demand in the last few months and the overall environment remains challenging on account of continued macro uncertainties. Near-term growth is likely to reflect the ramp-up in signed large deals, whereas discretionary spending is still weak. This is also reflected in the CY24/FY25 revenue growth guidance given by Indian/global IT services companies that have fallen short of expectations,” Mehta said.

Revenue growth continues to be impacted by a challenging macro environment, slower decision making, and softness in verticals like BFSI, retail, Hi-Tech, and communications. Amid the challenging demand environment, players are witnessing an increased mix of cost take outs and vendor consolidation deals that usually have longer tenure, thus leading to slower revenue conversion, he added.

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He expects IT stocks’ earnings downgrade to bottom out in H1FY25, if current expectations on the interest rate cut materialize. 

“Prices of our coverage IT services stocks moved up 6-13% in the last 1 week. Anticipation of growth recovery in CY25, steady cash generation, and higher payout would support valuation. However, after the sharp up-move last week and near-term demand uncertainties, stocks may take a breather,” Mehta said.

He prefers large-caps over mid-caps, considering relative valuation. His preferred IT stock picks are Infosys, HCL Technologies, and Wipro in large-caps. Among mid-caps, the brokerage house favors Cyient, Birlasoft, Zomato, Firstsource Solutions and Mphasis.

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For its top IT stocks picks, Emkay Global has the following ratings and target prices:

Infosys | Buy | TP: ₹1,750

HCL Technologies | Add | TP: ₹1,600

Wipro | Add | TP: ₹500

Cyient | Buy | TP: ₹2,600

Birlasoft | Add | TP: ₹760

Zomato | Buy | TP: ₹230

Firstsource Solutions | Add | TP: ₹220

Mphasis | Add | TP: ₹2,550

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Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.