US Fed rate cut bets, AI scope boosts IT outlook; Cyient, Persistent Systems, Mphasis among top mid-cap picks

Information technology (IT) stocks have regained steam amid rising interest rate cut bets from global central banks and the booming artificial intelligence (AI) opportunities relevant to the sector. The Nifty IT index has gained 3.2 per cent this week after US Federal Reserve Chair Jerome Powell signalled a rate cut at the central bank's September meeting. 

The NSE Nifty 50 index came off a record high on Wednesday, August 28, as profit booking across many sectors capped further gains in IT stocks. Nifty 50 settled 0.14 per cent higher at 25,052.35, while the 30-share BSE Sensex closed with a gain of 0.09 per cent at 81,785.56. The Nifty 50 has gained 3.8 per cent over 10 sessions, its longest winning streak since October 2020.

Also Read: US Fed set to announce first rate cut in four years next month: How will it impact India’s RBI policy? Experts weigh in

IT companies earn a significant share of their revenue from the US and are likely to benefit from the September rate cut. During the session, LTIMindtree rose 6.54 per cent, the most among IT stocks and on the Nifty 50, after Kotak Institutional Equities upgraded it to "add" from "reduce."

US Fed set to announce first rate cut in four years 

“The time has come for policy to adjust," Powell said in his keynote speech at the Fed's annual economic conference in Jackson Hole, Wyoming. “The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks."

He added that his "confidence has grown" that the battle against inflation is on track. In the last policy decision, Powell said if US inflation continues to fall, “a reduction in our policy rate could be on the table" when the Fed next meets in September. The market has largely priced in the Fed's expected 25 bps rate cut in September, so it lacks fresh catalysts to maintain and extend gains.

Fed chair Jerome Powell's led rate-setting panel ended its fifth policy-setting meeting for 2024 on July 31 and unanimously voted to keep the policy rate at the 23-year high.  Powell has set the stage for the central bank's first rate cut in four years, citing greater progress toward lower inflation and a cooler job market that no longer threatens to overheat the economy.

Also Read: US Federal Reserve ‘must go big with 50 bps interest rate cut in September’ or risk recession: Experts

GenAI boom

Generative AI investments have already started gaining pace, with hyper scalers building backend infrastructure to turbocharge the cloud ecosystem and SaaS products with AI capabilities while enabling IT service providers to orchestrate at the application layer. 

‘’Before we achieve the full-stack GenAI potential, outsourcing providers must work around fixing the foundational layer (consulting, data and modelling tool). This foundational phase would be followed again by developing digital assets (platforms and solutions) and scaling the final or third phase with commercializing offerings to support enterprise-wide applications,'' said Prabhudas Lilladher.

‘’We believe it will take a year or two for the investments to start generating a solid business outcome and capitalizing on GenAI’s true potential,'' it added. According to Bloomberg Intelligence, IT service revenue generated through GenAI is expected to contribute 6.6 per cent to the global GenAI revenue of $457 billion in CY27.

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Cyient, Persistent Systems, Mphasis among top mid-cap IT picks

According to domestic brokerage firm Prabhudas Lilladher, the near-term demand environment kept the large caps’ performance and outlook under pressure, which was recently joined by mid-cap IT stocks with notable volatility in their operating performance. However, the outlook for the mid-cap names remains strong for the rest of FY25, which are trading at a premium of around five per cent compared to large caps. 

As macro recovery gathers pace and spending sentiment improves, the brokerage believes mid-/small-cap IT outsourcing providers continue to benefit through the niche and deep expertise developed within key verticals along with execution agility and flexibility. 

‘’Participation in vendor consolidation and winning disproportionately over large caps and enterprise deal sizes become more fragmented and benefiting mid-caps vs one-shot large mega deal awarding to a single large vendor, in a bid to de-risk vendor dependency. With that, we initiate coverage on Cyient, Persistent Systems and Mphasis,'' said Prabhudas Lilladher.

Cyient: The brokerage expects aerospace and sustainability verticals to sustain the growth momentum and outpace consolidated revenue growth. 

‘’We expect Cyient's DET USD revenue and INR PAT to grow at a CAGR of 6.8 per cent and 9.8 per cent, respectively, over FY24-FY27E. Our SOTP-based target price of Rs2,130 implies an upside of six per cent. We initiate coverage on Cyient with an ‘ACCUMULATE’ rating; SOTP valuation implies target P/E multiple of 23x FY27E,'' said Prabhudas Lilladher.

Mphasis: With mortgage rates in the US showing early signs of moderation and macro indicators turning positive, the brokerage expects the company's DR business to recover from FY25. 

‘’We estimate revenue and earnings of the consolidated business to clock 10.7 per cent and 13.9 per cent CAGR, respectively, while the direct business would grow at a CAGR of 11.2 per cent over FY24-FY27E. We initiate coverage on Mphasis with a ‘HOLD’ rating, at a target price of ₹2,920 and PE multiple of 24x for FY27E,'' said Prabhudas Lilladher.

Persistent Systems: The brokerage expects Persistent Systems to outpace its peers yet again in FY25E with USD revenue growth of 15.9 per cent YoY, followed by a strong rebound in the following years with a CAGR of 17.4 per cent over FY24-FY27E. 

‘’However, we expect margins to be range bound in FY25E before improving by 80bps and 70bps in FY26E and FY27E, respectively. We initiate coverage on PSYS with an ‘ACCUMULATE’ rating, at a target price of ₹5,320 and PE multiple of 40x for FY27E,'' said Prabhudas Lilladher.

Also Read: Cyient approves sale of 14.50% stake worth 1.15 crore shares in Cyient DLM via block deal
 

IT sector outlook

According to Nasscom, the Indian IT market is expected to double to ~$500 billion in FY30, clocking a CAGR of ~12 per cent over FY24-FY30e. Historically, the Indian IT market has clocked ~7.4 per cent CAGR compared to global IT spending at five per cent over CY16-CY24E. 

With the anticipated surge in demand, Indian IT exports should continue to grow faster than that of global IT firms aided by incremental investments in generative AI (GenAI), supported by the ample availability of local talent pool at a much lower rate (avg. ~$ou29/hr).

Indian IT exports clocked a CAGR of ~11.7 per cent over FY15-23, partly led by global capacity centres (GCCs). According to the brokerage, exports are expected to accelerate to 13.3 per cent CAGR over FY23-30E. 

Considering the substantial technological churn, GCCs must continue engaging with third-party outsourcing providers. Due to their limited L&D resource and lack of multi-domain expertise, the gap between required new-age technology skills and available internal talent will always exist. 

‘’We believe outsourcing providers will continue to be a catalyst or facilitator for global enterprises in their journey to establish captives and drive innovation at scale,'' said Prabhudas Lilladher.
 

Disclaimer: The views and recommendations provided in this analysis are those of individual analysts or broking companies, not Mint. We strongly advise investors to consult with certified experts before making any investment decisions, as market conditions can change rapidly and individual circumstances may vary.