IT sector FY25 outlook: Uncertain macros to weigh on growth, says Prabhudas Lilladher; likes HCL Tech, TCS, LTI Mindtree

The Indian IT services companies ended FY24 on a weak note amid tepid topline growth and disappointing margin improvement. While the operating performance of Tier-2 IT companies continues to outpace the Tier-1 names, analysts believe valuations are supportive of selective names with better risk-reward and payout yield.

The median revenue growth for the IT sector in the fourth quarter of FY24 was 0.7% sequentially in constant currency (CC) terms. Tier-2 companies continued to outpace Tier-1 names and have reported median CC growth of 2.1% QoQ, while Tier-1 revenue growth came in at -0.6% QoQ CC. 

“The volatility within key verticals (BFSI, Retail and Communications) continue to affect topline performance, although the majority of the companies have reported either muted or positive USD growth within BFSI (median +1.9% QoQ), while Retail growth was weak (median –2.3% QoQ),” Prabhudas Lilladher said in a note.

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The operating margin was flat QoQ for the IT sector at 19.7%. The deal TCV during the quarter was strong at $27 billion, up 33% QoQ. Median Book-to-Bill (BTB) remains elevated at 1.2x for the sector, however the revenue conversion remains a challenge. 

“The spending reprioritization to core areas and broad-based cost-takeout theme continued through Q4, while project ramp-down or deal cancellations have been more pronounced for few companies at the onset of macro uncertainties,” said the brokerage firm.

The revenue growth outlook for FY25 has been discouraging with Tier-1 companies expected to report below mid-single digit growth on average, while Tier-2 companies are capping their revenue growth to high-single digits. 

“Unlike in FY24, companies have become more conservative in FY25 projections, and are baking in anticipated delays in executions and project closure activities. However, if the spending recovery coexists with an anticipated macro recovery in the near-term, then we might see an upward revision to the estimates for the companies as they progress through the year,” Prabhudas Lilladher analysts Pritesh Thakkar and Sujay Chavan said.

Also Read: IT sector recovery hopes pushed back to FY26; stock valuations attractive after recent correction, says Kotak Equities

Leaders and Laggards

Within Tier-1, TCS has relatively outperformed the peers and reported +1.1% QoQ CC revenue growth, while HCL Technologies reported +0.3% QoQ CC over a high base in Q3. On the other side, Infosys has been the outlier and reported another quarter of decline at 2.2% CC QoQ versus a decline of 1.0% CC reported in Q3.

Companies doubling down on margins

The demand environment remains unchanged in 4Q with large global enterprises continue to stay cost-focused and reprioritize areas of investments that are critical to their core operations and that can drive immediate ROI, the analysts said.

IT stocks to buy

Tier-2 has been outpacing the Tier-1’s performance and had been trading at a premium to them over the last couple of quarters, however, the suggested FY25 outlook across the board has been lackluster and has fallen below the anticipated line. 

As a result, the stock price correction was more pronounced in Tier-2 names than that of Tier-1, which led to convergence in the valuation gap between them, said Prabhudas Lilladher report. The brokerage remains selective on the Tier-1 names that are carrying diversified business mix, and having built strong ability to capture the current enterprise spends. 

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Additionally, with a median payout yield of 3.7% and 4.1% YoY in FY25e and FY26e, makes Tier-1 even more attractive, it said. 

Given a meaningful correction in the stock price for HCL Technologies, Prabhudas Lilladher is re-rating the stock to ‘Buy’ from ‘Accumulate’ earlier, with a target price of ₹1,550 per share.

The brokerage firm likes HCL Technologies, Tata Consultancy Services (TCS) and LTI Mindtree in that order. It has an ‘Accumulate’ rating on TCS shares and a target price of ₹4,360 apiece. It has also kept ‘Accumulate’ rating on LTI Mindtree with a target of ₹5,015 per share.

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