Indian IT Stocks On Cloud 9! What Next?

India’s IT-ITeS sector initially propelled because of the Y2K (the Year 2000) bug in the early 2000s and was able to thrive on the global stage as years passed. The Covid-19 pandemic has led to the Indian IT companies to move into the next phase of growth as companies (big as well as small) across the globe have started adopting newer technologies and shifting towards a digital environment.

The information technology sector was born much after India attained independence but is contributing almost 10% to India’s GDP, in comparison to the Automobile industry’s contribution of 8%.

The Indian IT industry has generated more than 4 million direct jobs to date and has been a beneficiary of a cumulative FDI inflow worth $44.91 billion for the last 20 years.

After getting hit in the first quarter of FY21 in the aftermath of the Covid-19 pandemic, India’s behemoth software companies have reported better than anticipated results in Q2FY21, with Wipro (NS:WIPR), Infosys (NS:INFY), and TCS leading the pack.

Driven by strong deal wins, a revival of demand, better than expected guidance, the Nifty IT index has delivered a return of more than 50% this year.

Aided by the recovery in the topline revenue growth and savings in costs due to lower administrative expenses with Work From Home (WFH) becoming the ‘new normal’, Indian IT firms have reported better than anticipated expansion in the EBIT (Earnings Before Interest and Tax) margin sequentially.

Source: News Reports, Tavaga Research

The IT industry employs about 4.3 million people as of the FY20. The industry added 205,000 jobs in FY20, up from about 185,000 jobs it added in FY19. It is also fuelling the growth of start-ups in India with about 5300 tech start-ups.

IT services, Business Process Management (BPM), and Software products & engineering services; all these sub-domains collectively form the IT industry.

Source: News Reports, Tavaga Research

Recent trends in the Indian IT industry

Digital services were among the fastest-growing business for information technology (IT) companies even before the pandemic hit. Coronavirus is expected to accelerate this trend as Indian and global clients ramp up their spending on artificial intelligence (AI), cloud computing, and the Internet of things.

NASSCOM, the IT industry lobby group, in a recent report, said that net global spending on digital solutions is expected to nearly double $2711 billion within the next four years through 2023. The table below illustrates the expected increase for individual technologies:


The Indian IT industry players

Tata Consultancy Services (NS:TCS)

TCS, a subsidiary of Tata Sons, essentially focuses on IT solutions, business solutions, and consulting.

Europe has, for the past 7 years, appointed TCS as the best company in customer satisfaction. The company has more than 5000 IT business contracts in Europe. In the second quarter of this fiscal, TCS recorded revenue of Rs 1,56,949 crore in FY20, growing 7.2 percent over the previous fiscal.

Source: Company Reports, Tavaga Research

The company has, of late, been increasing its focusing on the digital business. It generated Rs 17,053 crore in revenue through that in Q1FY21.

Source: Tavaga Research

The share price of the company has risen by almost 72 percent over the past 6 months. The market capitalization of TCS currently stands at Rs 10.92 trillion.

Infosys

Infosys is a large Indian multinational organization that offers its clients business consulting, outsourcing services and information technology.

The clientele of the company features 8 out of the 10 top US banks, 6 out of 10 global insurance companies and 9 out the 10 global companies in the pharmaceuticals industry. Infosys employs over 2.42 lakh people and is focused on the localization of the workforce. It also has more than 60000 employees in its digital business that includes AI, chatbots, etc.

In FY20, the company reported net revenue of Rs 9,07,910 million, 9.8 percent higher than FY19. The EBITDA margin in FY20 stood at 24.5 percent. The company posted a return on equity of 25.4 percent in the same financial year. More importantly, the company has a net debt to equity ratio of -0.4 in FY20. The adjusted PAT stood at Rs 1,66,400 million, 8 percent higher than the previous fiscal.

The chart shows the breakup of the company’s revenue by sector:

Source: Tavaga Research

The stock price of the company hit a 52-week high of Rs 1258.85 per share on 23rd December 2020, taking the market cap of the company to Rs 5.25 trillion. This comes after Infosys announced a mega-deal with Daimler AG (DE:DAIGn) to transform their IT infrastructure.

Source: Tavaga Research

This is the largest deal ever for the Bengaluru based company. It is bigger than the USD 1.5 billion deal it made with Vanguard in August.

Wipro Limited

The company is a global consulting, information technology, and outsourcing company, engaging in the development and integration of solutions. The IT Services segment provides IT and IT-enabled services including custom application design, IT consulting, system integration, BPO services, etc.

Wipro reported revenue of Rs 610 billion in the fiscal ended March 2020. The EBITDA of the company stood at Rs 122 billion, with an EBITDA margin of 20 percent.

Over the past couple of years, the company is investing heavily in research and development (R&D) of new technologies. The R&D spend has grown from Rs 304.1 crore in FY17 to Rs 419 crore in FY19, at a GAGR of 23.24 percent annually. 

The company’s share price hit a 20-year high of Rs 385.4 on 23rd December 2020, taking its market cap to Rs 2.18 trillion. The trigger for the share has been its deal with Metro AG.

Source: Tavaga Research

The mega-deal provides Wipro minimum revenue commitment of USD 700 million over a 5-year period. The minimum revenue rises to USD 1 billion if the deal gets extended by another 4 years to a total duration of 9 years. 

The table below lists other deals made by Wipro during the current fiscal:

Source: Company Reports

HCL Technologies (NS:HCLT)

HCL Technologies is a global technology enterprise that helps companies reimagine their businesses operation for the digital age. With a renowned management philosophy and a strong culture for innovation & risk-taking, HCL over the past several decades built innovative technology products and services.

HCL Tech reported revenue of Rs 706,780 million in FY20. EBITDA for the company stood at Rs 166,930 million, with a margin of 23.6 percent.

Source: Tavaga Research
 
The share price of the company is at Rs 917, with an m-cap of Rs 2.5 trillion. 

Persistent Systems (NS:PERS)

Being a global solutions company, Persistent Systems delivers enterprise modernization and digital business acceleration to enterprises operating across industries and geographies. It focuses on building a unique combination of powerful cloud-based platforms, applications, and tools for clients, by collaborating with various leading cloud companies as partners.

For the year ended March 2020, Persistent Systems reported revenue of Rs 35,658 million, with an EBITDA of Rs 4,930. The EBITDA margin for the company stood at 17.2 percent.

Source: Tavaga Research

The share price of the company is currently trading near its all-time high of Rs 1468.

Longer-Term IT Growth Story Intact

The majority of companies in and around India that have digital businesses set up have either maintained or increased their digital transformation budgets. Many organizations are yet to deploy essential digital capabilities.

In order to reduce operating costs, build new businesses to cater to customer behaviour changes, increase efficiency and productivity, and shift to new operating models, organizations are expected to spend heavily on tech integrations resulting in further growth of Indian IT companies.

Shares of the Indian IT firms have surged to record levels on higher demand for digital services amid the pandemic. The outlook for the IT sector remains positive, with digital services promising to contribute significantly to growth going forwards.

However, much of this positive outlook is priced in and it is recommended to be stock-specific while selecting stocks. The large-cap IT stocks should continue to do well, looking at the revenue pipeline and growth prospects, however, the mid-cap and small-cap IT stocks, which have had a stellar 2020, could face some market risks.

The Nifty IT Index has jumped about 52 percent YTD, compared to 13 percent for the Nifty 50 index. This surge has led to concerns about the valuations of the IT companies, as most of these firms are trading at higher than their historical average.

Disclaimer: The above analysis is not a recommendation to buy or sell but should only be used for educational and informational purposes.