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<\/p>\nAfter disappointing guidances in the first quarter (Apr-Jun) of the 2023-24 financial year (Q1FY24) and valuation downgrades, the Indian IT sector could see some positive repricing as the bad news for IT maybe easing in Q2FY24.<\/p>\n
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A key negative factor was weaker demand from the US financial sector and from North America in general.<\/p>\n
The latest GDP (gross domestic product) estimates and sector-specific news suggest that the demand situation may not be quite so bad with a gradual recovery in tech spending in Q2.<\/p>\n
In addition, growth in the engineering and R&D outsourcing (ERD) segment could be stronger than in other services segment.<\/p>\n
Large US banks spent more on tech (as a percentage of revenues) in Q2FY24 but at 6.6 per cent (versus 6.2 per cent in Q1FY24) this is much lower than peak levels of above 7 per cent in FY21.<\/p>\n
So there’s room for expansion here as macro-stability returns to the US.<\/p>\n
This would reverse a situation where Q1FY24 revenues were flat for IT companies.<\/p>\n
Banks across the world see the need to improve digital infrastructure to make them more efficient and gain market share.<\/p>\n
At some stage, given that US bank revenues have grown in double-digits, smaller banks are likely to start investing in IT following the lead of larger banks.<\/p>\n
From the IT services sector perspective, large-cap stocks look more attractive, for two reasons.<\/p>\n
One is that valuations for large IT companies are lower than mid-level and smaller IT firms.<\/p>\n
The other is that larger service providers could hold an edge when it comes to winning new business.<\/p>\n
It’s much too early to call a strong recovery but there’s relief that demand seems to have bottomed out and may be gradually recovering.<\/p>\n
Indian ERD companies will benefit more than other services segments from the recovery.<\/p>\n
There are some long-term growth themes and a trend of higher external sourcing.<\/p>\n
ERD services require domain-specific, contextual knowledge of the client’s business and strategies and therefore have very high correlation to client industry cycles with low ‘maintenance’ component of revenues.<\/p>\n
So, ERD growth is strong during periods of client industry technology transitions.<\/p>\n
Some of the growth will be captured by offshored GCCs (global capability centres) and while this generates employment, it doesn’t translate into revenues for listed Indian firms.<\/p>\n
But, a lot of ERD revenues will accrue to Indian IT outfits.<\/p>\n
Areas of strong demand include digital engineering, and offshoring.<\/p>\n
Digital engineering will be leveraged across product lifecycles of design, production, maintenance and disposal.<\/p>\n
Technology transitions in manufacturing are also led by increased software induction and innovations in smart manufacturing.<\/p>\n
Digital ERD spend may represent 59 per cent of global ERD spend by the 2026 calendar year or CY26 (up from 45 per cent in CY22).<\/p>\n
Sub-areas of interest will include “cloudification” across all segments, connectivity changes (driven by 5G penetration), convergences in IT-IOT processes, smart manufacturing, and massive transitions in transportation, including inductions of autonomous vehicles, electric vehicles, and also transitions across industries driven by sustainability concerns.<\/p>\n
Apart from the software and internet sector itself, segments like automobiles, BFSI (banking, financial services and insurance), media, healthcare could be other areas of fast ERD growth.<\/p>\n
Quite a few ERD plays are relatively small\/ mid-level stocks such as Cyient, Persistent Systems, Tata Elxsi, KPIT, etc.<\/p>\n
Despite the gloomy advisories, the NSE IT Index is up 12 per cent in CY23 – and almost all of those gains have come since April 2023 – that is, in FY24.<\/p>\n
The IT index is up 19 per cent in the last 12 months.<\/p>\n
It has outperformed the Nifty50, which is up 10.5 per cent in the last year.<\/p>\n