Axis Securities lists KPIT Tech and Persistent Systems as top Tier-2 IT sector picks post Q1 earnings

The Indian IT services sector has demonstrated improved performance in the June quarter (Q1FY25), signaling a revision in demand and stabilization of uncertainties in key global economies. While there is a faster recovery in AI use cases, ER&D, and other emerging technologies, discretionary spending remains cautious due to ongoing macroeconomic concerns, said brokerage house Axis Securities in its recent IT sector review note.

Post the Q1 earnings, Among Tier-1 tech companies, the brokerage likes Infosys and Tech Mahindra, while KPIT Tech and Persistent Systems are its preferred picks within the Tier-2 segment.

Despite easing supply-side constraints, margin performance in Q1FY25 was mixed. Among Tier-1 techs, Wipro displayed strong execution with margin expansion, while Tech Mahindra's margins are beginning to recover from unsustainably low levels observed in FY24, noted the brokerage. Wage hikes across most IT services companies impacted margins for the quarter. Meanwhile, Tier-2 techs, which maintained or improved margins from FY20-23 through superior growth, faced margin pressures in FY24, with companies like Persistent seeing a YoY decline despite certain one-time reversals, it pointed out.

It further added that Midcap/Tier-2 IT services companies are now guiding for stable margins in FY25. Going ahead, Axis expects only a modest recovery in FY25E and recommend a tactical approach.

Moreover, the brokerage emphasised that despite ongoing uncertainties, deal wins have remained resilient across the sector. Demand for emerging technologies like AI, Cloud Transformation, Data Analytics, and IoT continues to be robust, with many companies achieving record-high deal closures. This indicates that once macroeconomic conditions improve, the sector is well-positioned for a strong V-shaped recovery, forecasted Axis.

IT Sector Outlook

Axis Securities projects a cautiously optimistic outlook for the IT services sector, which, despite facing challenges from economic slowdown and macroeconomic uncertainties, is expected to see improving demand across geographies. Resilient deal wins, particularly in retail and manufacturing, reinforce confidence in a rebound in automation spending over the next few quarters, said the brokerage.

"The Indian IT services industry is showing early signs of recovery as macroeconomic uncertainties begin to stabilize. However, the long-term outlook remains robust, supported by indications of broader economic recovery. It is anticipated that this recovery will commence at the start of the new year, with strong revenue growth expected in H2FY25," said the brokerage.

Moreover, the demand for emerging technologies like generative AI, machine learning, IoT, and cloud transformations remains stable and Axis anticipates it recovering swiftly as certain macroeconomic challenges ease. Additionally, a potential dovish stance by the Federal Reserve could further enhance macroeconomic conditions in North America, driving demand for IT services, stated the brokerage.

Key Monitorables

Rate cuts in North America could significantly boost the Indian IT services sector, driving a sharp recovery. Furthermore, as the banking crisis eases, confidence in automation spending is likely to rise, particularly in the BFSI vertical, leading to a potential resurgence in this key sector, added the brokerage.

Stock Picks

KPIT Tech: The brokerage has a buy call on the stock with a target price of ₹2,150, implying an upside potential of over 17 percent.

The shift from traditional to digital engineering is driving accelerated demand across various industries, such as Manufacturing, BFSI, and Healthcare, creating significant opportunities for the company. The Passenger Car vertical showed strong 5.2 percent quarter-on-quarter growth, with key client revenue rising 3.8 percent QoQ and client concentration increasing to 86 percent. Feature development and integration services grew 2 percent QoQ, cloud-based connected services saw a 0.6 percent increase, and Architecture and Middleware consulting surged 13.7 percent. Given these growth metrics, the company’s strong growth potential, backed by solid deal making and excellent execution capabilities justifies a 58x P/E multiple on FY26E earnings, resulting in a target price of ₹2,150 per share, noted the brokerage.

Persistent Systems: The brokerage has a buy call on the stock with a target price of ₹5,410, implying an upside potential of over 10 percent.

Persistent Systems is demonstrating robust growth despite a challenging market environment, bolstered by strong client engagement and significant deal wins, highlighted the brokerage. In Q1FY25, the company secured a solid total contract value (TCV) of $462.8 million and anticipates further margin improvements. The UK market shows increased demand for cost optimization with faster decision-making, while Europe is affected by macroeconomic issues but is expected to stabilize soon. With a strong deal pipeline and long-term contracts with major global brands, Persistent is well-positioned for continued expansion and revenue growth, it noted.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before taking any investment decisions.