The Indian IT services industry is facing near-term challenges due to the economic slowdown and weaker macroeconomic outlook. However, its long-term outlook remains robust with the economy showing signs of recovery. In a recent Q4 review note, brokerage house Axis Securities said it believes that the said recovery will begin in the start of the new year and FY25 will show strong revenue growth.
“After strong revenue growth momentum in FY22 and FY23, we believe IT services may face challenges on demand and margin fronts on account of the economic slowdown and macroeconomic uncertainties. We have a skeptical near-term outlook due to delayed decision-making for automation,” said the brokerage.
However, it further noted that deal wins remained resilient even during the difficult times, which gives it confidence that automation spending will rebound strongly in the next couple of quarters. Demand in industries such as retail and manufacturing remains strong and is expected to regain momentum in the near future.
The brokerage continues to believe that most IT services companies will regain momentum in a couple of quarters as deal wins remain resilient and supply-side challenges ease. The dovish stand taken by the Federal Reserve may encourage macroeconomics in North America which may drive demand for automation spend. Post the Q4 results, the brokerage has recommended 2 stocks from the IT space – Persistent Systems and KPIT Technologies.
But first, let’s take a look at some key highlights from the Q4 earnings.
Revenue
The brokerage pointed out that most IT companies reported disappointing revenue growth in Q4FY24, reflecting subdued demand from major global economies. The Indian IT services sector does not anticipate a swift recovery in discretionary spending due to ongoing macroeconomic uncertainties. Revenue growth from North America continues to lag behind Europe for Tier-1 tech companies, as seen in recent quarters, it noted.
The BFSI sector experienced tepid growth, with no immediate improvement in discretionary spending, though some improvement is expected in FY25. Verticals like Telecommunication and Hi-Tech are also struggling to demonstrate strong growth. The outlook remains challenging, with many IT services companies lacking near-term visibility, said the brokerage.
Margin
As per the brokerage, the margin performance for Q4FY24 was mixed, despite reduced supply-side constraints. Among Tier-1 tech companies, TCS and Wipro showed strong execution with margin expansion for the quarter. TechM’s margins have begun to recover from previously unsustainably low levels. Most Tier-1 techs, except for Infosys and TechM (due to significant ongoing restructuring), managed to slightly improve margins in FY25 despite weak revenue growth, helped by tight cost optimisation, including lower subcontracting expenses, it informed.
Conversely, Tier-2 techs, which had previously excelled at defending or improving margins through FY20-23 due to superior growth, saw margins come under slight pressure in FY24. Companies like Persistent reported a year-on-year drop in margins despite benefiting from some one-time reversals, further stated the brokerage.
Meanwhile, mid-cap IT services and Tier-2 IT services companies, which showed relative margin resilience through FY21-23, were affected by moderating growth in FY24. Only a modest recovery is expected in FY25, leading to a tactical approach preference for TechM among Tier-1 techs and KPIT, Zensar, and Firstsource among the Tier-2s, it recommended.
Deal Wins
Deal wins remained resilient despite ongoing uncertainty. The demand for newer technologies such as AI, cloud transformations, data analytics, and IoT remains strong, with the majority of companies closing all-time-high deals. This indicates that when macroeconomic factors turn positive, there will likely be a strong V-shaped recovery, it said.
Top Sector Ideas
Persistent Systems: The brokerage has a ‘buy’ call on the stock with a target price of ₹4,350, implying a potential upside of over 24 percent.
Persistent Systems’ consistent growth, as highlighted by Axis Securities brokerage, persists amidst challenging times, driven by enhanced client engagement. In Q4FY24, Total Contract Value (TCV) remained strong, totaling $447 million in deal wins. Management’s confidence in gaining medium-term demand momentum, supported by previous quarter wins, remains high, with anticipated margin improvement.
The brokerage also noted ongoing strength in medium-term demand, particularly emphasising higher cost optimisation deals in the UK with faster decision-making, while the European market continues to be affected. Expectations of macroeconomic stabilisation suggest an uptick in decision-making. Across various verticals such as BFSI, Pharma, Tech, and Others, encouraging quarter-on-quarter growth ranging from 1% to 4% was observed. Most verticals showed robust growth trajectories, further bolstered by a strong deal pipeline in the near term.
“We believe Persistent is well positioned for encouraging growth given its numerous long-term contracts with the world’s leading brands. Improved revenue visibility gives us confidence in the company’s continued growth. We assign a 35x P/E multiple to its FY26E earnings of ₹125.8/share to arrive at a TP of ₹4,350/share, implying an upside of 24% from the CMP. Hence, we recommend a BUY rating on the stock,” said Axis.
KPIT Technologies: The brokerage has a ‘buy’ call on the stock with a target price of ₹1,750, implying a potential upside of over 16 percent.
Axis Securities observed KPIT’s performance, noting the rising demand for digital Engineering, Research, and Development (ER&D) services across various industries. This transition to digital engineering presents significant opportunities for KPIT in sectors like Manufacturing, BFSI, Media & Technology, Retail, Healthcare, and Travel & Hospitality.
In the Passenger Car vertical, KPIT achieved a robust quarter-on-quarter growth of 6.2%, with management expressing confidence in maintaining this momentum. Strategic revenue from key clients increased by 8.4% quarter-on-quarter, while client concentration rose slightly from 85% to 86% from Q3FY24 to Q4FY24.
KPIT’s services mix remains strong, with feature development and integration services, constituting 90% of revenue, showing solid growth of 7.5% quarter-on-quarter. Cloud-based connected services, contributing 26% of revenue, continued strong growth at 9% quarter-on-quarter, while Architecture and Middleware consulting, comprising 29% of revenue, demonstrated growth of 6.1% quarter-on-quarter, as noted by Axis Securities.
“Given the company’s strong growth potential, supported by solid deal-making and excellent execution capabilities. We assign a 47x P/E multiple to its FY26E earnings of ₹37.1/share to arrive at a TP of ₹1,750/share, implying an upside of 16% from the CMP. Hence, we recommend a BUY on the stock,” it said.
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 taking any investment decisions.
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