Why are IT Stocks Falling?

After being the darling of the market post covid for almost 18 months (about 1 and a half years), IT stocks remain one of the worst-performing sectors in the last one year. The worsening macro-economic situation with rising inflation along with interest rates along with geo-political tension has put worries of growth slowdown globally. The year 2022 saw major challenges for tech companies due to Russia's invasion of Ukraine, and rising inflation.  All this has put pressure on the IT sector domestically and the share price of IT companies saw a major downturn in the last few quarters.

Major Reasons for Fall of IT Sectors Stocks

1. Fall in Profit Margin

FY23 started with a hustle bustle of Ukraine and Russia war, which impacted the world hardly from food inflation to supply chain issues than energy crises in Europe. The companies also got effected by the war, the margins fell for most of the companies due to rise in cost of raw material, supply chain issue, and covid in China.

Below is the table and chart containing margins of Indian IT companies from Q3FY22 to Q3FY23:

2. Increased Interest Rate 

We expect that companies would likely postpone capital expenditures in 2023 due to uncertain demand and rising borrowing rates. Demand for residential real estate may also be impacted by rising mortgage rates. This also means that the margins of companies which have already taken debt may also suffer with maintaining profitability margins. 

3. Rupee-Dollar Exchange 

India is an emerging economy and India is a net importer economy which leads to the weakening Indian rupee.  While the Reserve Bank of India has been strongly supporting the Indian Rupee. We expect the rupee's underperformance against global currencies to continue. While this can also act as a very good time for India to play out with global players looking for China plus one strategy, which can probably lead to a boost in India’s exports. 

4.  Macro level concern 

As majority of the revenue of the Indian IT companies comes from abroad, the sector was broadly impacted by number of macrolevel concern that affected its overall performance.

Some of the macros like furloughs in the developed economies and a drop in discretionary spending in tech, telecom, and other verticals were higher than expected during the fiscal year which led to the subdued performance of the IT stocks.

In the recent terms, the banking crisis in the US and Europe had a negative impact on the Indian IT business process management industry, which draws close to 41% of its revenues from the BFSI sector. 

5. Global recession concerns still here 

Growth in emerging markets, including India, has been significantly hampered by slower global growth and a tightening global monetary environment brought on by higher generalized inflation in advanced economies.

The retail inflation reading in India for February 23 was once again above the RBI's upper tolerance range. The headline inflation rate for the month was 6.4%. (YoY). Retail inflation increased 0.2% sequentially, compared to 0.5% the previous month. Price pressures are expected to continue throughout the fiscal year, with headline inflation hovering around 6%. Another rate hike, albeit limited to 25 bps cannot be ruled out at the RBI’s next policy meet in early April 2023.

6. Brokerages cite valuation concerns 

According to a CRISIL report, headwinds in key markets, especially the BFSI segment in the US and Europe, will affect the revenue growth of domestic IT services companies. While BFSI segment revenue growth is expected to halve to mid-single digit, it would be marginally offset by 12-14% growth in the manufacturing segment and 9-11% growth in other segments. Net-net, there would be moderation in overall revenue growth. Notably, IT expenditure by clients is witnessing a shift towards cost optimisation and vendor consolidation away from discretionary spending by most end-user industries.

IT Share Valuation  

Valuation of IT stock has significantly corrected, due to concerns of recession in US and Europe, as US and Europe regions generated more than half of the revenue for the Indian IT company. Due to this concern, the IT index was the worst performing index in CY22. Our analysis says that the BFSI sector was one of the major contributors to the revenue of IT companies, and due to the ongoing credit and banking issue in the US we expect that BFSI sector will mute its discretionary spend on IT and we can see a fall in revenue for IT companies in this segment. 

Performance of Indian IT Stocks in 2022 and 2023 

The Indian IT sector is on the brink of experiencing positive outlook as majority of the IT stocks are available at a cheaper valuation compared over their median P/Es. The last 12 months have seen a double-digit growth in earnings, making it more attractive to potential investors. It appears unlikely that IT will bud in the near future.

IT firms have improved their margins by 40-70 basis points due to the rupee's fall versus the dollar, allowing them to renegotiate better arrangements with their clients. 

Earnings commentary from Indian IT players under our coverage for Q3FY23 reflected a cautious optimism about demand, particularly for cost-cutting projects. Additionally, companies had a positive outlook in sectors such as energy and utilities, manufacturing, travel, and hospitality. TCV (total contract value) for large-cap IT services increased in Q3 by 10-67% year on year, with stable-to-improving book-to-bill ratios.