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Fed’s dovish commentary has raised hopes of demand inflection in the sector. That is not a given. Last two times Fed cut rates this sharply - 2000-01 and 2007-09 - IT Services growth plummeted. While probability of a soft-landing this time makes the cause-effect relation (rate cut -> demand inflection) still plausible, absence of any precedence make the timing between the two suspect. A better guage of demand in 2024 should therefore be on-ground tangible evidences. Those are hardly encouraging. US Banks are talking about NII compression in 2024 as deposits reprice. Basel III endgame proposal could compress banks’ ROE. Enterprises across sectors are still treading on cost optimization path. UK’s demand has turned incrementally weak. These are reasons enough for clients to hold off discretionary spend in 2024. That is not fully appreciated. Street’s optimism on INFO’s FY25 USD revenue growth (c.8.3%), for example, is hinged on mega deals’ contribution. Deceleration of smaller, discretionary projects could offset part of that. We estimate that INFO’s initial FY25 growth guidance could be as low as 4-6%, triggering estimate reset across large-caps. That would cap incremental re-rating as well. Moreover, NIFTY IT’s earning yields has converged with US-10Y yields, making re-rating less likely. That said, we realise that multiples may not correct much. We therefore raise target PER across coverage to align with current valuations. A modest return in 2024 is our base case. Mid-caps with growth momentum behind them are better bets.

? Prediction I: Purse strings to stay tight: Discretionary spend may remain elusive even in 2024. As we noted in Budgets ain’t budging, 2024 IT budgets will likely be flattish. ACN commentary and our recent interactions with companies corroborate this. Clients have reasons to be cautious. US Banks could face pressure on ROE due to a) NII compression as they reprice deposit; and b) higher capital requirement due to Basel III endgame proposal. There are also evidences of enterprises continuing with their efficiency programs. Nike just announced a USD 2bn cost reduction program. Fedex’s “DRIVE” program to cut USD 1.8bn of operational cost is on-going. AT&T increased its cost saving target by USD 2bn.

? Prediction II: INFO to guide for 4-6% growth: Street’s FY25 USD revenue estimate for INFO builds contribution from mega deals. But it ignores impact of smaller/discretionary revenue run-off, in our view. Two datapoints indicate the imapct (of smaller deal) could be substantial. One, our TCV-revenue waterfall model suggests contribution of large deal to INFO’s revenues rose to c.53% in 1HFY24 (vs. 49% in FY23). Two, even at upper end of its FY24 revenue guidance, contribution of its FY23 net new deal wins to FY24 incremental revenues will be c.11%, lowest since it started reporting this metric. We believe full year impact of FY24 run-offs could partially offset contribution from mega deals in FY25, especially if core volumes don’t pick up. We therefore estimate that INFO’s initial FY25 growth guidance could be as low as 4-6%. We are building in 6%.

? Prediction III: Multiples will not re-rate: 8% upmove in NIFTY IT since mid-Dec has pushed down its earnings yield closer to US 10Y bond yield (Exhibit 6), theoretically making it less attractive than US bonds. Last time this happened (pre-GFC), NIFTY IT’s earnings yield spiked (or PER contracted steeply). While rate cut expectations will push yields down, any drop in earning yields might negate that. We therefore don’t see any imminent PER expansion. In fact, lower than expected INFO’s FY25 guidance could could reverse some of the recent re-rating in the sector. Another argument against re-rating is that multiples have not corrected at all in 2023, despite sharp earning cuts. Top-5’s FY24/25E EPS were cut by 2-45% through 2023. PER, in contrast, were up by (1)-51%.

? How should one position in the sector? Overall, we expect the sector to give modest returns, at best, in 2024. A likely weaker FY24 exit and potentially lower than expected initial FY25 guidance could offer investors better entry point post Q4 results. We believe mid-caps with growth momentum will continue to out-perform large caps despite heady valuations. Coforge is our top mid-cap pick. We prefer WPRO among large-caps given low valuation on lower expectations. Besides, higher consulting exposure means its growth could be first off the block, if discretionary spend were to rebound.

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