IT has been one of the worst-performing sectors in 2022, so far. Amongst the Nifty 100 stocks, four of the IT stocks have lost between 40-50%, and three have shedded away 20-30%. This is far more than the market correction, and one may be tempted to hunt for value here.
But is the downside really over? We think not! Here's why:
The IT sectors gets more than half its revenue from the US. And the US is in bad shape right now with inflation soaring high, and the Fed hitting the peddle hard on interest rate hikes. The economic cool down is expected to be harsh, and that will affect the IT budgets of most customers of IT companies.
While the US economy is slowing down, there are also fears of a recession in 2023. Whenever sentiment amongst buyers goes low, we’ve seen issues like delayed decision making, longer deal closure cycles, pressure on pricing and renegotiation of contracts, which not only add pressure on revenues, but also on margins.
Post the initial negative impact of COVID, IT companies had seen a sharp increase in growth, setting a high base to match up during these tough times. Earning downgrade cycles will add to the pressure on stocks.
Valuation for IT companies is still high. It has come off its peak, but definitely higher for the kind of earnings growth, and risks associated with the sector. The sector is still trading at a 35% premium to the Nifty 50. Just to put that in perspective, the average premium over the last 20 years has been 22%. And during relatively bad times (2008-10 and 2016-20).
With this, it’s a tall ask for the sector to perform well in the near-term. The possible triggers are a better outlook in the US, or valuations becoming further reasonable - both of which seem only likely after some more downside.