The Indian IT sector has been one of the most brutally hit sectors in the recent market volatility. Since the beginning of the year, the IT index has fallen by 15%. Stocks across large and mid caps are down, through time periods - the last week, month and year-to-date.
Why the fall?
The sector has been underperforming for several reasons, which may continue to weigh on the sector going ahead. Some of them include:
Demand for IT services had bounced up during the pandemic as the world took to digital transformation. However, with things normalising, it is going to be difficult to maintain high growth rates going ahead.
The macro environment has been deteriorating as inflationary pressures impact client budgets; amid other factors like geopolitical tensions, rising interest rates and supply chain disruptions.
Supply side pressures have been mounting at current demand levels, and attrition continues to remain high. In this context, employee expenses increase and margins come under pressure.
Price hikes with clients havre been in discussion. However, the benefits of price hikes comes with a lag given the negotiation cycle and for new better-priced contracts to start ramping up.
FII selling has been high in the sector, resulting in added selling, and pressure on stock performance.
While issues because of which IT stocks have been down may continue in the near-future, the larger concern is around current valuations. The sector has been trading at valuations that are steep, and at a massive premium compared to historical valuations. This leaves little room for disappointment.
With either growth or margins faltering, valuations are bound to correct. The gravity of correction gets exacerbated at times when high valuations are at risk, given macroeconomic conditions, risk aversion in the markets and rising interest rates.
With this, the sector may take a hit in the near-term.
However, given strong deal wins, order bookings, and a plausible debate of new-age services being of critical value (and hence not being impacted by macro conditions), the medium to long term outlook for IT services companies continues to remain strong.
We have limited exposure to the IT sector in our portfolios.
We recently exited Persistent Systems from Rocketship in the April 1, 2022 rebalance to book profits.
TCS is part of Rocketship
Infosys is part of Bread & Butter
TCS and Infosys, despite declines have declined much lesser compared to the other names in the sector. That said, given their high-growth, stability and fundamental strength, we are continuing to hold on to them. We will take a call on this again in the July 2022 rebalance (or earlier if we have a change in view)!