Information Technology: Waiting For A Fresh Breakthrough

Investors are grappling with uncertainty regarding the IT industry, sometimes impressed by its technological strides, including artificial intelligence (AI), and overarching growth potential. Yet, they remain wary due to global uncertainties, dismal performance by industry leaders, significant layoffs, and a prevailing pessimistic sentiment. Mandar Wagh analyses the financial performance of IT companies, providing insights into growth triggers and risk factors, offering investors a comprehensive understanding of the industry’s road ahead 

The information technology (IT) sector is undergoing a tumultuous journey, marked by pronounced peaks and valleys that consistently make headlines due to factors such as quarterly earnings, significant layoffs, attention-grabbing senior leadership turnover and groundbreaking advancements in technologies, including artificial intelligence (AI). The BSE Information Technology index, a sectoral indicator for the IT industry, witnessed an impressive rally of over 200 per cent in the aftermath of the corona virus pandemic from April 2020 to April 2022. 

However, it subsequently entered a protracted downturn and has since remained within a narrow trading range. For a brief period, the scenario shifted for IT stocks as global recessionary worries alleviated, rekindling investors’ confidence in the sector. A notable correction had rendered IT stocks available at appealing discounted prices, yet this wasn’t sufficient to sustain the optimism. Let’s delve deeper to analyse the financial performances of IT companies, considering headwinds and tailwinds on both domestic and global fronts, and exploring the future outlook for the sector. [EasyDNNnews:PaidContentStart]

Financial Performance

Tata Consultancy Services (TCS), India’s leading software service provider, announced an approximately 8 per cent year-on-year (YoY) growth in revenue, with a net profit of ₹ 11,380 crore, reflecting growth of 8.74 per cent YoY and 2.34 per cent sequentially. Although the company’s revenue aligned closely with analysts’ projections, its net profit fell short of street estimates. The company stated that robust deal momentum contributed to a substantial order book in Q2FY24, coupled with a promising pipeline. 

This positive outcome was attributed to clients’ persistent interest in exploring Generative AI (Gen AI) and other emerging technologies. With a 6.72 per cent YoY growth in revenue, Infosys Ltd. reported a mere 3.14 per cent rise in its consolidated net profit for Q2FY24, reaching ₹ 6,215 crore. The optimism waned further after the company announced revised revenue guidance, narrowing it down from the initial range of 1 per cent to 3.5 per cent to a more restricted 1 per cent to 2.5 per cent. 

HCL Technologies outperformed its major peers, demonstrating an upbeat financial performance marked by an 8.05 per cent YoY revenue growth and a notable 9.92 per cent surge in net profit to ₹ 3,833 crore. When evaluating the performance of the top 30 IT companies based on market capitalisation, the IT sector displayed modest sequential growth with an average of 2 per cent in revenue and 7 per cent in net profit. On a year-on-year basis, the sector exhibited resilience, showcasing an impressive average revenue growth of 22 per cent and a substantial net profit surge of 40 per cent. 

In a contrast to the lacklustre performance of key IT constituents within the BSE Sensex, several Small-Cap companies have outshone, demonstrating remarkable doubledigit year-on-year growth in both top-line and bottom-line. Zen Technologies Ltd., RateGain Travel Technologies Ltd. and KPIT Technologies Ltd. garnered investor attention by showcasing robust revenue growth. Meanwhile, Nucleus Software Exports Ltd., Zensar Technologies Ltd., Cyient Ltd. and RateGain Travel Technologies Ltd. stood out as top performers in terms of year-on-year net profit growth.

Equity Markets and IT Stocks

Despite achieving the longest winning streak since 2007, characterised by an impressive 11-session rally and substantial surges in between, the Indian benchmark indices BSE Sensex and Nifty 50 exhibited lacklustre performance over the past year, registering a modest growth of only 5-6 per cent. Geopolitical tensions, such as the Russia-Ukraine war, global uncertainties, recessionary fears, a sharp selloff in global markets triggered by a surge in 10-year US Treasury yields to a 16-year high, and various other factors, collectively contributed to the absence of investor optimism. 

The BSE Information Technology index, which experienced a narrow trading range and more declines throughout the year, gained momentum in the latter half, achieving a 12 per cent return over the last six months. Shares of Tata Consultancy Services remained relatively flat throughout the year, posting a marginal increase of 2 per cent. Infosys’ shares witnessed a decline of more than 11 per cent over the past year, significantly impacted by the FY23 results and the recent announcement of a reduction in revenue guidance. 

HCL Technologies and Tech Mahindra managed to hold their ground, delivering considerable returns of 16 per cent and 11 per cent, respectively, over the last year. Being one of the top 10 leading IT companies by market capitalisation, KPIT Technologies stood out by defying the general trend of muted performance among industry majors, doubling the wealth of investors over the last year. Simultaneously, investors were drawn to multibaggers such as Archana Software Ltd., Danlaw Technologies India Ltd., Aurionpro Solutions Ltd. and Blue Cloud Softech Solutions Ltd., which increased their wealth by leaps and bounds in an otherwise challenging sector environment!
 

Risk Factors

Numerous challenges are surfacing within the global IT industry, ranging from persistent macroeconomic uncertainties to concerns about a looming recession and reduced spending in pivotal markets, notably the US. Given that a considerable share of revenue for the Indian IT industry is derived from the US markets, it too finds itself grappling with the sector-wide downturn. This is evident in noteworthy layoffs, diminished bonuses and restricted pay hikes, all stemming from a reduced demand scenario. Recognising the inherent risk in depending heavily on a few major clients is crucial. 

The potential loss of a significant client or encountering diminished demand from key clients could significantly impact revenue streams. Even as prominent domestic IT companies forge strategic partnerships with global industry leaders, the swift pace of technological progress has the potential to make current skills and services obsolete. To remain relevant, companies need to consistently allocate resources to training and development initiatives. For instance, domestic companies find themselves in intense competition with well-established AI platforms, necessitating the need for a competitive advantage to position themselves at the forefront and harness the benefits of this global technological trend. Also, AI-focused IT companies must navigate the landscape of stringent data privacy regulations set forth by the Indian government.
 

Growth Triggers

The rapid evolution of the global IT industry is fuelled by extensive digital transformation, propelled by the emergence of various emerging technologies such as artificial intelligence, machine learning, computer vision, block chain, robotics, Internet of Things (IoT), quantum computing, augmented reality (AR) and virtual reality (VR). AI stands as a beacon of hope for the struggling IT industry, offering a ray of promise due to its versatile applications across numerous sectors. Its potential for substantial future demand is particularly evident in industries like BFSI, healthcare, e-commerce, media, marketing, security, and research and development. 

India has solidified its position as a premier off-shoring destination for IT companies globally. Demonstrating prowess in delivering services both on-shore and off-shore to clients worldwide, the advent of emerging technologies presents an entirely new spectrum of opportunities for leading IT companies in India. Leading companies are leaving no stone unturned in their pursuit to align with prevailing technology trends, positioning themselves to reap the benefits of this global movement. Infosys and Microsoft have joined forces to deliver advanced AI-enabled solutions, aiming to expedite widespread adoption across industries. 

Tech Mahindra unveiled collaboration with Google to introduce ‘amplifAIer’, a Generative AI-driven email, as part of its suite of AI solutions. Meanwhile, Wipro has unveiled plans to invest USD 1 billion in AI over a span of three years. 

Recently, it has also entered into collaboration with NVIDIA to advance artificial intelligence applications in healthcare. Both Reliance Group and Tata Group have already formalised strategic AI partnerships with NVIDIA. In addition, the strong deal momentum observed in leading IT companies has resulted in a substantial order book in Q2FY24, instilling optimism among these companies despite the overall gloomy global outlook. 

The Indian government is actively working to bolster the industry. In the Union Budget 2023-24, the allocation for the IT and telecom sector reached ₹ 97,600 crore. Additionally, the cabinet has given approval for the PLI Scheme 2.0 for IT hardware, featuring a budgetary outlay of ₹ 17,000 crore. As per a survey by Amazon Web Services (2021), India is expected to have nine times more digitally skilled workers by 2025. If future developments include improvements such as a strengthened global macroeconomic outlook, a decrease in recessionary concerns and increased spending in key IT markets, this scenario would offer an additional boost to the global IT industry, further fortifying the position of the domestic IT sector. 

Click here to download Financial data of IT stocks 2023

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