After JP Morgan, Nomura Downgrades Indian IT Stocks. What’s Brewing in this Space?

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Global research and brokerage firm, Nomura has become bearish on the Indian IT sector. The firm has downgraded many frontline Indian IT companies and slashed the target prices by a noticeable cut. It sees hard times ahead for IT services providers and a potential drag in the demand for their services in FY24.

The firm has cut targets of tech giants such as Tata Consultancy Services Ltd. (NS: TCS ), HCL Tech (NS: HCLT ), L&T (NS: LART ) Technology Services Ltd (NS: LTEH ), Wipro (NS: WIPR ) etc. 

It is the second downgrade on the Indian IT industry in a short span of time. A few days back global investment bank JP Morgan had also released a report, slashing targets of many IT firms, citing reasons on the supply side of the industry. So, what’s happening in the IT space that’s forcing analysts toward a negative outlook? There are primarily two reasons.

Sky-High Valuations

The IT sector has been one of the best performing sectors after the COVID-19 pandemic. The sudden need to bolster IT infrastructure to allow employees to work from remote locations led to a massive demand for IT shares. The result being, that these IT shares soared to a valuation which was difficult to be sustained, especially after the world started to open up and remote work didn’t seem much of a need.

It is common for the market to give a high P/E multiple to high-growth tech companies, however as the central banks around the world started to increase interest rates, including the RBI, these valuations made little sense to investors. Even after a decent correction in the IT stocks this year, at present, stocks such as Tata Consultancy Services, Coforge Limited (NS: COFO ), Mphasis (NS: MBFL ), etc. are all trading at a P/E of above 30.

Soaring inflation, leading to supply constraints 

Increasing inflation is one of the biggest culprits that has led analysts to turn to a not-so-good outlook for the IT industry. The IT industry pays a major chunk of its input cost in the form of salaries to employees. 

India has no shortage of supply for IT services professionals. However, high inflation would make it difficult to onboard good talent without increasing the salary brackets. Also, employee retention and attrition rates would directly align with an increase in paychecks.

After JP Morgan’s downgrade, the Nifty IT tanked over 5% in a day. Today, Nifty IT fell 2.9% to a new 52-week low of 27,708, by 12:10 PM IST. The index has corrected around 30% from its 52-week high of 39,446.7, marked on 4 January 2022.

Talking about individual IT giants, TCS is trading 2.74% down at INR 3,198, Infosys (NS: INFY ) is down 1.38% to INR 1,421.05 and L&T Tech is trading 3.41% down at INR 3,409.7.

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