This midcap IT stock is down 15% this year so far; ICICI Direct sees a 25% upside potential; here’s why

Midcap IT stock Sonata Software has been under pressure this year so far. However, according to ICICI Direct, the stock has a robust long-term growth outlook. The brokerage firm has a buy call on the stock with a target price of ₹770, implying a 25 per cent upside potential.

Till the August 19 close, Sonata Software share price has lost about 15 per cent this year, while the equity benchmark Sensex has gained over 11 per cent. On a monthly scale, the stock is down over 15 per cent this month after a 15 per cent gain in June and a 25 per cent gain in July.

In intraday trade on Tuesday, August 28, Sonata Software share price fell over a per cent. The stock hit its 52-week high of ₹867.10 on February 27 this year and its 52-week low of ₹469.05 on June 4 this year.

ICICI Direct positive about Sonata Software

ICICI Direct pointed out Sonata Software expects Q2 to be stronger than Q1, with accelerated growth momentum anticipated from the second half of the current financial year (H2FY25).

"The management remains confident in achieving their $1.5 billion target by FY27, albeit delayed by two to four quarters. The IITS (IT services) pipeline is healthy and supported by three large deals won across healthcare, manufacturing, and BFSI," said ICICI Direct.

"Long-term growth is driven by AI, large deal traction and key client contributions. We expect IT services to grow at a 12.8 per cent CAGR over FY24-26E in dollar terms with a nearly 8.9 per cent growth in FY25," said ICICI Direct.

For Q1FY25, Sonata Software reported a 12 per cent year-on-year (YoY) drop in its consolidated net profit at ₹106 crore. The revenue from operations for the quarter rose 25 per cent YoY to ₹2,527 crore, while EBITDA came in flat on a YoY basis at ₹176.2 crore.

ICICI Direct underscored that Sonata has faced some challenges in terms of delayed pipeline conversion. However, it sustained its growth momentum with three large deals and 14 new clients in Q1FY25. Another 49 large deals are under pursuit, with 47 per cent of the active pipeline consisting of large deals.

"With a strong large deal pipeline, the company is poised for growth in the future, with execution being key. Management has also reiterated that 20 per cent of the revenue will come from AI services in the next three years. Approximately 67 per cent of their employees are GenAI level-1 trained," ICICI Direct said.

According to the brokerage firm, the company's management highlighted that it would continue to face headwinds from delayed decision-making, project completions in the UK/Europe and softness in retail and manufacturing as well as a large deal won in healthcare, which would be margin dilutive over the next two to three quarters due to the onsite model & upfront AI investment made.

"The margins in Q2/Q3 are expected to be impacted by wage hikes. Nonetheless, IITS margins will likely recover by FY26 to the normalised mid-20s levels versus low 20s likely in FY25," said ICICI Direct.

"Sonata's long-term growth momentum hinges on its large deal wins, robust pipeline, and advancements in AI. We have a positive outlook on the company, factoring in the near-term margin challenges and ongoing growth initiatives," ICICI Direct said.

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