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Our analyses of 22 global technology companies’ recent quarter performance and management commentary suggest stability in demand rather than optimism. Macro uncertainties and an elongated sales cycle continue to weigh on demand and growth visibility. A majority of the companies have resisted predicting the recovery timeline, with the occurrence of recession being an irritant in any normalization. On the flip side, for the longer term, all companies remain optimistic, with technology becoming a key enabler in the enterprises’ digital-transformation journey. Enthusiasm surrounding technology has been further fueled by the advancement of AI, a theme that was highlighted by companies across the spectrum. AI is predicted to transform the way enterprises operate, unlocking tremendous business value. Tech companies are gearing up to enable this transformation, even as the adoption remains in a nascent stage, and complete transition remains at least a few years away. Nifty IT Index outperformed broader markets by ~6%/~5% in the last 1M/3M. The U.S. economy’s resilience and stability in the demand environment suggest that the valuation of IT stocks may be sustained; however, the upside would be capped as further rerating requires an earnings upgrade, in our view.

Stability in demand; caution persists in the near term

The demand environment is exhibiting some stability, although possibility of near-term demand acceleration seems low. An uncertain macro environment continues to impact customers’ decisionmaking, leading to an elongated sales cycle and additional deal approval layers. Consequently, projects that are considered to be more discretionary in nature are being delayed, predominantly in the U.S. Companies continue to experience softness in the flow of smaller, shorter-duration contracts. However, there is sustained demand for cost takeout and transformation programs that can deliver meaningful RoI. The deal pipeline remains healthy; however, an elongated sales cycle weighs on conversion. The translation of bookings to revenue growth is impacted by the change in the deal mix. Incrementally, over the last few quarters, some companies have highlighted improvement in general sentiments and engagement, while revenue recovery remains patchy.

AI to be a potential game changer

All companies, without any exception, have highlighted the potential of AI to transform the way enterprises operate. AI is now part of every company-client discussion. Companies have already jumped on the AI bandwagon and started embedding AI as part of their offerings. We believe the initial impact of AI will be felt in productivity improvement with use cases like code generation, content creation, and contact centers seeing initial attraction. Adoption of AI continues to remain in the nascent stage, with enterprises still in the process of ‘experimenting’ and building PoC for use cases. We believe enterprises will scale up the adoption of generative AI over time and IT companies are likely to play a major role in this process, with revenue possibly starting to accrue as early as in the next couple of quarters. As in the past, we believe the ‘real benefits’ of AI should start to accrue only post this transition process, which is still a few years away. We believe, over the longer term, AI will have a net positive impact; however, in the interim, it may have a deflationary impact due to better productivity.

Read through for IT companies

Commentary from global companies indicates that clients’ ‘wait and watch’ policy continues as recession fears have sustained; while on the positive side, no companies have pointed to any deterioration in the operating environment. This cautious approach from clients has already resulted in muted expectations for CY23/FY24 (our estimates for -1% to 7% growth for large caps). As the U.S. economy continues to remain resilient over the last few quarters, clients’ reluctance to spend over the fear of an impending recession may possibly recede. This can lead to H2FY24 performance being better than H1. A favorable exit rate in FY24 may lead to lower risk to our FY25 estimates. We remain positive on the earnings acceleration in H2; however, after the recent run-up in the stock prices, valuations are no longer cheap. We believe any deterioration in the macroeconomic environment, which can negatively impact H2FY24 performance, poses a risk to our FY25 estimates. Nifty IT Index outperformed the broader markets by ~6%/~5% in the last 1M/3M. The U.S. economy’s resilience and stability in the demand environment suggest that valuation of IT stocks may sustain; however, the upside would be capped as further rerating requires an earnings upgrade in our view. Our pecking order is INFO, WPRO, HCLT, TECHM, LTIM and TCS in tier-1 companies; and ZOMATO, ECLX and FSOL among mid-cap companies.

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