IT is a secular growth sector. Valuations are now reasonable: Edelweiss

Realistic Expectations, Reasonable valuations; Either recession fear overstated or growth moderation yet to play out

Festina Lente (meaning Make haste slowly) – Suetonius Augustus

Quick Summary: We are making a case that IT services sector expectations are now reset at realistic level, and under a scenario of receding global macroconcerns, coupled with reasonable valuations (refer earlier note “pessimism overdone”– link) we are continuing with our view (elaborated in 2QFY23 preview) that there is near-term trading upside but medium term view is uncertain as it is too early to disregard macro-induced demand concerns (despite receding macroconcerns, we are likely to get clarity only by 1QCY23 and will reassess our medium term call). Long term, no point belaboring (again) that, anyway IT is a secular growth sector. Therefore, we continue with a view that there is near-term trading upside and to build position gradually with an option to consider buying aggressively only after clarity in/around 1QCY23 i.e. Festina Lente. We continue to prefer large-caps/larger-midcaps with top picks as Infosys (CMP INR 1636, Mcap INR 688,294 cr), LTI (CMP INR 4938, Mcap INR 86,607 cr) and Persistent (CMP INR 3971, MCap INR 30,346 cr) and LTTS (CMP INR 3886, Mcap INR 41,026 cr).

IT sector reset at realistic expectations in near term: Over last 2 quarters IT results are a study in contrast –not because sequential growth was materially different, but because, despite similar growth, 1QFY23 was considered underperformance while 2QFY23 is considered outperformance (refer exhibit 01). Implying, what has changed is our/street/consensus expectations, not companies performance per-se (infact, except for some details about few more geo/verticals facing headwinds, overall commentary about demand, pipeline, and contract booking is largely unchanged in 2Q v/s 1Q). This is in-line with our 2QFY23 preview (2QFY23 = 1QFY23 + some margin expansion) and made a case that IT stocks could be considered gradually buying for trading upside though it is too early to disregard macroinduced demand concerns.

IT sector at reasonable valuations: We elaborated earlier that IT stock’s valuation has corrected 17%-49% and Nifty IT index valuation corrected by 27%. Since then, valuations have inched up but valuation is broadly within the reasonable band (albeit at higher side of the band) adjusted for RoCE & growth rate expansion post-pandemic.