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Recent events in global banking are impacting decision-making cycles; we expect weak sequential growth in Q4FY23E

IT companies under our coverage, ahead of their silent period, have mentioned increased cautiousness among clients around decision-making due to heightened uncertainty arising from the recent banking crisis. Deal pipelines have not shrunk, but conversion to new deal wins is taking longer time. Also, in certain cases, conversion of orderbook to revenues in terms of deal ramp-ups is taking longer than usual. This, in our view, implies right-
shifting/postponement of demand to H2FY24E or even FY25E as digitalisation agenda of clients remains largely intact, but their near-term focus has shifted to cost optimisation and increasing efficiency. Although our covered companies’ exposure to US regional banks in at best in low-mid single digits of overall revenues, the overall exposure to BFSI vertical isquite significant. This might lead to a decline in sequential revenue growth this quarter. Hence, we expect muted sequential revenue growth in the range of -1.9% (HCLT) to +0.5% (LTIM) in CC terms with BUY-rated TCS / INFY at 0.1%. Due to cross-currency tailwinds of 100-150bps during the quarter as major currencies like GBP, EUR, JPY appreciated against the greenback, USD revenue growth of companies under our coverage would be higher than CC revenue growth.

We expect limited EPS cuts for our coverage universe and we believe that these potential EPS cuts are more than factored-in the 12% valuation correction for NIFTY IT since mid-Feb’23

Due to delay in decision-making and potential technology budget cuts in the near term, we are lowering our FY24E EPS estimates by up to 5% and making limited changes to outer year EPS estimates due to right-shifting of demand. Here we assume no further escalation of banking crisis globally, in terms of bank failures apart from what has been seen up till now., which we believe has been more than factored in the recent valuation correction for
NIFTY IT, which has fallen from 24x 1-year forward P/E valuation in mid-Feb’23 when we initiated coverage on the sector (Link) to 21x now, implying 12% correction. At 21x P/E valuation, NIFTY IT is trading close to its last 5-year average valuation and has scope for further rerating in our view given the secular technology demand cycle we are currently into (around cloud migration and digitalisation). In this note we also present a bear case scenario along with sensitivity analysis of EPS and target multiple to our implied target prices, in case the banking crisis globally deepens with more bank fall-outs. Such a situation might lead to heightened crisis of confidence resulting in lower credit growth, loan defaults and lower global GDP growth – resulting into reduced tech spend outlook, particularly discretionary spend. On the flip side, we would like to highlight clients’ increased focus on IT outsourcing and cost optimisation, which is the key strength of Indian IT vendors, particularly our BUY-rated INFY and TCS. In such situations, market share gains accelerate for these players on account of vendor consolidation and potential buyout of captive units of F500 or G2000 enterprises.

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