Early signs of an impending recession in the United States are now visible at some of India’s biggest software services firms. Still, all is not lost.
On Friday, shares of HCL Technologies Ltd. the most since August after India’s third-largest IT firm tempered its revenue growth guidance for fiscal 2023. It was only in October that the company the metric to 13.5%–14.5% from 12%–14% guidance for the first quarter of the fiscal.
“I’m sure a lot of you are concerned about the macro backdrop,” C. Vijayakumar, CEO of HCL Technologies, said during the company’s Investor Day held in New York on Thursday. “Some of the macros—for example, the furloughs and the drop in discretionary spending in tech, telecom, etc.—are a little bit more than what we expected at the beginning of the quarter.”
“Given that narrow band and given the macro feedback we have today, I think we’ll be at the lower end of our guidance of 13.5%–14.5% for the full year,” he said.
“We do expect this to be an industry-wide problem and not an HCL Tech-specific one,” Girish Pai, head of research at Nirmal Bang Institutional Equities, wrote in a note. “Instead of a typical budget flush, there is likely underspending of budgets that could affect December quarter revenue.”
To be sure, October-December is historically a seasonally weak quarter due to furloughs and fewer working days in the US—the biggest market for Indian IT companies. But with the US and Europe staring at recession—courtesy of a hawkish US Federal Reserve and the Ukraine war—the seasonal weakness is exacerbated. A weaker rupee isn’t much comfort either, as spending power is curbed due to sky-high inflation on both sides of the Atlantic.
The current valuations in India’s IT space are “unsustainable in a worsening US macro scenario,” brokerage Credit Suisse . The market capitalisation of the big four—Tata Consultancy Services Ltd., Infosys Ltd., HCL Technologies Ltd., and Wipro Ltd.—is likely to correct by 10–27%.
“We see HCL Technologies at high risk of an over 20% valuation correction, compared to about 15% for Infosys and Wipro and around 8% for Tata Consultancy Services,” Credit Suisse Research Analyst Alok Srivastava wrote in the note.
That puts revenue at high risk of cuts, but not earnings, due to several margin levers in place.
Still, some see a limited downside for India’s IT sector due to the uncertainties stateside.
“We do not see a large impact on IT companies as of now. The correction we are seeing in stock prices is due to uncertainties. There will be no impact on earnings per share,” Omkar Tanksale, senior research analyst at Axis Securities, told BQ Prime’s Hiral Dadia during an interaction.
“We do not see a margin impact on the bottom line in the near term, but we are cautious on FY24,” he said.
To be sure, HCL Technologies has not cut its revenue growth outlook but simply said that the topline will come in at the lower end of the guidance, Tanksale said.
“The furloughs in the BFSI space have happened due to automation. In the case of HCL Tech, we should also look at their product-and-platform business, which remains strong in Q3,” he said. “Newer projects may get delayed due to macro uncertainties, but existing contracts have sustainability going forward.”
Vijayakumar of HCL Technologies indicated as much.
“We continue to see decent bookings in this quarter. We have a decent pipeline to deliver decent bookings in the next quarter,” he said at the investor day. “We still believe we are in good shape to meet our guidance.”
According to Tanksale, any large revision in revenue guidance is unlikely in the near term. The business momentum, triggered by digital transformation during the pandemic, will sustain itself, he said.
So, what should an investor do now, in this current environment? Stay put, Tanksale said, but diversify the portfolio within the sector to avoid the isolated pain points. The time is ripe for the new investor as well, provided they are in it for the long haul.
All metrics considered, Infosys Ltd. is Tankale’s top pick in the large-cap space, and Persistent Systems Ltd. is among midcaps due to the cloud deals it has struck.
“The demand for digital transformation, which surged during the pandemic, is still there,” he said. “Large deals may get delayed, but they aren’t going to go away. Stay invested in FY24.”