With IT companies making big strides, investors are flocking to IT stocks, despite worries if the rally would last beyond the Covid woes. Experts see sustainable growth for the Indian IT sector, backed by solid macros and rising global demand
When all lines went off, online came into play, more overwhelmingly than ever. That was the reality the first bout of the pandemic had unleashed last year. As online became the lifeline for most part of the world, the IT sector made a sudden surge to make the best use of the adversity. The virtual world took over when the real world stood motionless.
The surge in the IT industry has fuelled a rally in IT company stocks and the S&P BSE IT Index doubled from 12,224 points to 28,385 points between two consecutive Aprils.
“In relative terms, the rise (in the IT Index) is in line with the main indices, with the Nifty doubling from 7500 points to 15000 points in the same period,” says Kishor Ostwal, Chairman and Managing Director of CNI Research, who feels that the sector has the potential for a further 25 per cent appreciation in the next 12 months.
The second wave of the Covid-19 pandemic has made us even more dependent on the digital world. And, this will only intensify as we move on.
“We believe the 2021-22 earnings will see a cyclical recovery but after cyclical recovery in FY22, growth will return to trend,” says Ashwin Mehta, Research Analyst for Technology at Ambit Capital. Also, margins could peak in 2020-21 and moderate, as supply side risks and one-off temporary cost saves across travel, facility expenses and discretionary spends reverse partially with Covid combat measures being eased systematically.
From school education to corporate board meetings, from political rallies to medical consultations, and from banking to shopping – digital transformation has changed the way we have lived and worked all our life in the last one year. In fact, our dependence on information technology has made us look for robotics for doing household chores. And, this is not only in India, which has been one of the hardest hit in the second wave of the pandemic, this is a global phenomenon now. The Covid crisis has accentuated the growth of the industry.
As more and more investors turn to IT stocks, experts suggest a very selective approach in making the choice. “The investors should take a more nuanced approach, rather than paint the whole IT sector with the same brush,” says Ambit’s Mehta.
Although market experts are divided over the choice of IT stocks to invest in, there is a consensus that the investor must have an in-depth understanding about the company and the sector it deals in.
Mehta recommends stock picking based on evaluation of circumstances of each company individually. Companies focussed on faster growing segments or on recovering segments like infrastructure management and engineering research and development (ER&D), or stronger in-app modernisation and automation are good picks.
“Look at the company’s growth prospects and valuations, given the sharp outperformance seen in the sector and individual companies in the past 12 months,” says Manik Taneja, an IT Services Research Analyst at JM Financial Institutional Securities.
Omkar Tanksale, Senior Research Analyst at Axis Securities, bats for large-cap stocks like TCS, Infosys, HCL Tech, Wipro and select midcap companies like Mindtree, LTI, Persistent Systems and Coforge because of better management and corporate governance. He also feels that a long-term (one to two years) investment will help to even out price fluctuations.
“I like TCS and Infosys at current levels,” says Ostwal, who feels that in the IT sector, one needs to look at larger companies as integrity and reliability are a must in this sector.
For the new entrants to the equity markets, buying exchange traded funds (ETF) are easier and safer than investing directly, which calls for a lot more studies and analyses and a lot more time. IT ETFs come up as a good option for investors looking at the industry. It would allow the investor to participate in the IT growth story, without needing to go through the hassle of picking individual stocks, according to Chintan Haria, Head of Product and Strategy at ICICI Prudential AMC.
The IT Index is on a swing, the market has just hit record highs and some volatility is on because of the uncertainty created by the second Covid wave, and the economic recovery is largely on track with an estimated double-digit GDP growth for the current fiscal. The current investor frenzy for IT stocks has also fuelled a rally in the stocks of IT service companies.
The digital transformation has unleashed a surge in cloud computing, data centre, automation, robotics and cyber security. As global companies get hit by the economic slowdown, there is an increased adoption of technology to improve their cost-competitiveness and this is where the Indian IT services companies play an important role.
The availability of skilled and trained manpower in India is also a significant advantage for Indian companies, though this is partly offset by higher attrition and increasing wage pressures. “We have already seen an increase in offshore delivery by approximately 400-600 bps over the past 12 months,” says Taneja. One basis point (bps) is one hundredth of a percentage point.
The resurgence of the IT sector was inevitable but the velocity and momentum of growth was the flip side of the Covid crisis and we’re closing in on a solution to check the pandemic. For an investor, it is a cause for concern for his returns, when the world will come out of the shadow of this dreaded menace and peace is restored.
“Across all sectors and large companies worldwide, an urgent need was felt for a digital transformation in their business processes, with the pandemic only accelerating the need for such a transformation to facilitate better engagement with customers and suppliers particularly in a restrictive social environment,” says Suman Chowdhury, Chief Analytical Officer, Acuité Ratings & Research.
The experts believe that the new normal will be a mix of ‘physical and digital’ with the digital frontiers opening up new vistas for both the life and livelihood. The relatively inexpensive Indian IT companies will continue to attract global attention, overrunning American players and its skilled manpower resource will also remain a top preference for global giants.
Despite the industry logging in impressive growth and spreadsheets showing sustainable prospect for the near to mid-term investments, there are some bugs in the system, as glitches are referred to in the IT parlance. “There will be a massive demand for newer technology that will put pressure on the legacy business for IT companies which, in turn, will temper growth,” says Mehta.
The value of the Indian National Rupee is often perceived as a deterrent for the IT industry. Usually, a 1 per cent depreciation in the value of the rupee adds 30-40 bps to the operating margins of IT companies, but only in the short term and also subject to other costs remaining constant. “We believe that by the end of 2021-22, the rupee per dollar rate will be at Rs 73,” says Tanksale. Depreciation of the greenback may impact the operating margins for the companies by 1-2 per cent, but that will be offset mainly by higher offshoring and lower subcontracting costs.
India’s emergence as the fifth largest global economy gives the industry a strong foundation for growth. Supportive government policies, push for a digital economy, and favourable macroeconomic factors will make the IT surge sustainable.
The writer is a financial journalist