IT stocks rally up to 32% in 1 month. Will Q1 results mark end of sluggish revenue growth?

Amid expectations that the June quarter results may mark the bottom of sluggish revenue growth for software exporters, shares of IT companies have rallied up to 32% in 1 month. The Q1 earnings season begins next week with TCS and HCL Tech releasing its numbers on 11th and 12th July, respectively.

"We believe 1QFY25 will mark the bottom of sluggish revenue growth for the Indian IT services sector. While a strong recovery in discretionary demand may take a few more quarters, it is unlikely to worsen further, in our view. Interest rate cut cycle (likely in 2H CY24) and a potential thaw in decision-making by US corporates post US elections in Nov 2024 could provide fillip to demand," Nomura's Abhishek Bhandari said.

The Japanese broking firm has tweaked earnings by -3% to +5% for FY25-26F for IT stocks in its coverage universe.

Analysts expect the revenues of IT services companies to recover following a tepid 4QFY24 for the industry, as the ramp-up of large cost-takeout deals could drive growth for large-caps in a seasonally strong quarter.

"The brutal winter of discretionary spend cuts in the industry is likely over, but there is little evidence of a recovery in the flow business. Hence, we are on track for one of the weakest first quarters for at least 10 years. The situation, though slightly better, is eerily similar to what we witnessed in 1HFY24," Motilal Oswal said.

In the last one month, Nifty IT index is up over 15% with Persistent being the top gainer with an upside of 32%. Wipro shares are up nearly 23%, Tech Mahindra 20% and LTIMindtree 16%.

JM Financial expects largecap players to report -110 to +50bps QoQ EBIT margin movement in Q1.

"We see specific factors impacting margins. Wage hike and lower growth will weigh on TCS and HCL margins respectively. INFO’s margin has tailwinds from absence of Visa cost and partial reversal of one-off impact in 4Q (100bps due to contract rescoping). We expect 75-100bps margin contraction for Coforge/PSYS without wage hike, on seasonal factors (Visa)/deal transition cost," it said.

The first quarter is also anticipated to be affected by visa costs, leading to a slightly negative bias for the quarter. "We believe FY25 will be a year of restrained wage hikes across the industry. Moreover, given the gradual nature of demand recovery, companies can adopt a more cautious approach towards their hiring strategies. This should lead to better margin defense for the sector," Motilal Oswal's Abhishek Pathak said.

Which stocks to buy?

Nomura has upgraded Wipro, Infosys and HCL Tech to buy ratings and TCS to neutral from reduce rating. Its top picks in the sector are Infosys, Wipro and Tech Mahindra (among large caps), and Coforge and Birlasoft (among midcaps).

For JM Financial, Tech Mahindra remains a buy on turnaround hopes while KPIT and Tata Tech are structural bets on Auto ER&D theme.

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of Economic Times)