After Infosys, HCL Technologies Revises Its FY24 Guidance, As Challenges Loom Over India’s IT Sector, A Look at Ongoing Headwinds and Prospects For FY24

HCL Technologies, following Infosys, has revised its FY24 guidance downward even as it witnessed an 18% gain in its shares in 2023; a stark contrast to Infosys, which witnessed a 4% drop, and TCS, which saw a 9% rise.

However, HCL Tech’s management anticipates a revival in the second half of FY24, but it also reduced its revenue growth forecast for FY24 during its September quarter results announcement.

The move has raised concerns about the overall outlook for the IT industry for the rest of the financial year as analysts were taken by surprise at this adjustment in guidance, raising questions about whether the IT firm is feeling the impact of declining discretionary demand.

According to analysts, a reduction in revenue guidance often signifies a longer path to recovery, even with notable deal wins.

HCL Tech has revised its CC revenue growth guidance from 6-8% to 5-6%, but it has maintained its Ebit margin at 18-19%, which analysts believe is still attainable; the revised guidance implies a compounded quarterly growth rate of 3.3-4.5% for the next two quarters.

Market Reactions
Nomura India commented, “We are reducing FY24-26F EPS by 1% due to the miss in 2QFY24. Our FY24-26F EPS projections are 2-3% lower than the Street’s.
As a result, we are decreasing the target by 1% to Rs 1,200 based on a three-staged growth model.” The brokerage has a preference for Tech Mahindra in the large-cap space.

Nuvama Institutional Equities stated that HCL Tech’s Q2 performance was decent, and although the guidance cut was sharp, it was largely expected. “Even with the reduced guidance, it is likely to be the fastest-growing large-cap IT services company. Its decent growth in services and lower exposure to the troubled BFSI (23%) segment suggest a high probability of stable earnings growth. The high dividend yield and inexpensive valuation (18.5x FY25E PE) provide support for the stock price,” noted the domestic brokerage.

According to Sharekhan.”We project a healthy revenue/PAT CAGR of 8% and 9% over FY23-26E. The stock is trading at a reasonable valuation of 19.4 times and 17.5 times its FY25E and FY26E EPS, respectively. Therefore, we continue to recommend buying HCL Tech, with a revised price target of Rs 1,400 (the increase in PT reflects the rollover of the valuation multiple to FY26E EPS).”

For the December quarter, Dolat Capital expects strong revenue growth of 4.9% sequentially, primarily driven by the Software vertical due to positive seasonality.

However, it anticipates a 35 basis point decline in HCL Tech’s margins on a QoQ basis due to the impact of impending wage hikes for mid and junior employees, effective in October.

“We anticipate that macroeconomic volatility will continue to affect IT Services in the near future, potentially moderating revenue momentum. We expect HCL Tech to maintain a moderate revenue momentum over the next 2-4 quarters, translating into mid-single-digit revenue growth, and we anticipate that it will sustain its current valuation range of 16-19 times, implying 2 times on a PEG basis. Our target for the stock is Rs 1,210,” as suggested by Dolat Capital.

Infosys Story So Far
Infosys pleasantly surprised analysts by outperforming street expectations with a significant revenue boost and steady margins. However, the enthusiasm was dampened by a downward revision in revenue guidance for FY24.

Despite this setback, Morgan Stanley remains optimistic about Infosys’s prospects for the coming year, foreseeing robust EBIT growth thanks to improved revenues and margins.

Nonetheless, there is a potential decline in P/E (price-to-earnings) multiples on the horizon, stemming from the unexpected reduction in revenue guidance and cautious remarks from the management.

Infosys has yet again lowered its FY24 revenue growth guidance from 1-2.5 per cent, a cut from the earlier estimate of 1-3.5 per cent. Analysts at Nomura attribute this guidance cut to a pullback in discretionary demand and a slowdown in decision-making while maintaining the margin guidance.

On a more positive note, Infosys managed to sequentially increase its EBIT margin to 21.2 percent in Q2 FY24, despite challenges arising from increased sales of third-party hardware and software.

Recent large deal wins have showcased Infosys’s strength in application services and its ability to secure cost take-out and transformation projects, which bodes well for future opportunities.

Kotak Securities noted that, although the outlook for discretionary spending remains uncertain, Infosys has successfully secured a fair share of large deals, providing some visibility for FY2025E.

However, despite the management’s references to strong deal wins supporting FY25E growth, the weak exit rate of FY24 indicates that FY25 growth is likely to be in the mid-single digits.

Nuvama Institutional Equities expressed concerns about Infosys’s performance, attributing it to company-specific issues exacerbated by unfavorable economic conditions expecting Infosys to underperform its peers in the near to medium term.

Infosys reported the highest-ever large deals, totaling $7.7 billion in Q2FY24, a remarkable 185 percent year-on-year increase. These figures represented a significant 2.5-fold increase quarter-over-quarter, with net new deals accounting for an impressive 48%.

According to Motilal Oswal Financial Services, the downward revision in revenue guidance may negatively impact short-term stock prices. However, the brokerage firm had already foreseen subdued FY24 revenue growth for Infosys and expects a limited impact on the company’s overall growth trajectory from the consecutive reductions.

Despite the anticipated macroeconomic uncertainty affecting FY24 growth, FY25 is poised to benefit from the substantial deals secured this year.

The domestic brokerage expects the company to achieve a 9 per cent YoY constant currency (CC) USD revenue growth in FY25 as macroeconomic conditions improve. They are keeping an eye on the potential rise in pass-through revenue contribution as the share of large deals continues to increase.

Despite the strong sequential growth, Bernstein foresees a negative market response to the guidance cut, as indicated by a 7 per cent decline in Infosys American depositary receipts (ADRs) overnight, thus suggesting the possibility of a significant drop in Infosys shares on October 13.
In the previous session, Infosys shares concluded 2.82 per cent lower at Rs 1,452.30 on the NSE.

IT Industry To Face Headwinds
India’s IT sector is poised to grapple with macroeconomic challenges until the close of 2023; as a result, the companies within the IT industry have seen a significant decline in their stock values during 2023 due to these macroeconomic headwinds.

Similarly, the results for the March quarter from major IT players like TCS, Infosys, and HCL Technologies have reaffirmed the sector’s ongoing slowdown.

The IT sector in India has been facing difficulties due to the repercussions of a banking crisis in the US and Europe, coupled with mounting concerns about an impending economic recession in developed markets and unfortunately, analysts don’t anticipate an improvement in this situation until the year’s end.

In the face of this sector’s persistent weakness, foreign portfolio investors (FPIs) have been divesting from IT companies; notably, FPIs turned bearish on both the IT and oil and gas sectors in March, selling equities valued at ₹13,734 crore within these sectors.

Analysts foresee that the challenges posed by macroeconomic factors, such as high inflation, interest rates, and the banking crisis in the US and Europe, will necessitate vigilance for the IT sector over the next few quarters.

The primary concern for the IT sector is the slowdown in growth and the looming possibility of a recession; as long as the slowdown persists and global economic growth remains uncertain, the market is expected to anticipate reduced order flow, slower execution, and pricing challenges.

These factors, in turn, will place IT companies under stress, and their valuations may remain stagnant, and investors are advised to stay vigilant for the next one to two quarters until there is more clarity on the global economic outlook.

The Growth Projections
The latest fourth-quarter results and FY24 growth predictions for major IT companies highlight the ongoing challenges in the sector.

Infosys, for example, reported a growth of 15.4% in constant currency terms for FY23, falling short of the 16-16.5% guidance provided in Q3. Furthermore, Infosys has projected a 4-7% revenue growth for FY24, marking the first time it has guided for single-digit revenue growth in constant currency terms since FY16.

Tata Consultancy Services (TCS), a major competitor, reported a constant currency revenue growth at an 11-quarter low of $7.2 billion in Q4; simultaneously, the company’s CEO noted stress in its largest market, North America, where the anticipated recovery has yet to materialize.

According to Sanjeev Hota, the Vice President and Head of Research at Sharekhan BNP Paribas, the sector’s macroeconomic uncertainty is unlikely to improve in the next 2-3 quarters.
Stability may only be achieved towards the end of the year as the US and North America, key markets for the sector, are not expected to recover in the near term.

IT Companies Stock Performance
The global growth slowdown has taken a toll on the stock performance of IT companies, with the Nifty IT index declining by 30% in 2023, compared to a 3% drop in the broader Nifty50 index.

The banking crisis in the US and Europe, triggered by incidents like the collapse of Silicon Valley Bank and Signature Bank in the US and turmoil at Swiss lender Credit Suisse, has added to the challenges faced by Indian IT companies as they have significant exposure to US banks, have neared their 52-week lows since March.

While most of the price damage in IT stocks has already occurred, the sector’s outperformance from its current levels is expected to be limited until global macroeconomic headwinds stabilize.

The sector’s valuation multiples are closely tied to earnings growth, and if growth falters, IT stocks are unlikely to outperform broader market indices.

Weak US performance is expected across companies reporting in the coming days, particularly in the banking, financial services, and insurance (BFSI) and telecom verticals; thus, it is anticipated to affect companies like Tech Mahindra and Mphasis, which have substantial exposure to these sectors.

The Viewpoint
The IT sector in India is facing a challenging macroeconomic outlook, and FY24 may prove to be even tougher as the US and European economies grapple with slowdowns due to rate hikes; hence, the full impact of these challenges may become more evident in FY24.

The Last Bit
India’s IT sector is grappling with a series of formidable macroeconomic headwinds. While the worst of the stock price declines may have already occurred, recovery and outperformance from current levels remain uncertain until global macroeconomic conditions stabilize.

The challenges tied to high inflation, interest rates, and the enduring banking crisis are expected to demand vigilance from IT companies and investors for the next few quarters.

The industry’s outlook for the remainder of 2023 remains challenging, and the full impact of these macroeconomic hurdles may become more evident in FY24.