Worst over for Indian IT sector? Here’s what experts say as they pick TCS, Infosys, Birlasoft among 12 IT stocks to buy

As concerns over a slowdown in the US economy resurfaced after weaker-than-expected August manufacturing number, several large IT stocks, including Infosys, TCS and Wipro, fell 1-3 per cent in intraday trade on Wednesday, September 4, dragging their sectoral index, Nifty IT, lower by a per cent.

The August US manufacturing data underscored subdued factory activity in the world's largest economy, reigniting fears of a looming recession and weighing on market sentiment globally.

The US is a key market for Indian IT service provider companies, where they earn a significant part of their revenue. Fresh US data reveals that the worst may not be over for the Indian IT firm.

However, several IT stocks have seen healthy gains recently after talks of a September Fed rate cut gained momentum. On a monthly scale, the Nifty IT index has been rising since June this year. If it closes in the red in September, it will snap the winning run of the last three consecutive months.

Experts and brokerage firms have started observing green shoots and revised their sector outlook.

Brokerage firm Nirmal Bang has upgraded its stance on the Indian IT services sector from ‘underweight’ to ‘overweight’.

"We anticipate a robust double-digit EPS (earning per share) growth (17.5 per cent CAGR) from FY24 to FY27E, driven by (a) solid TTM (trailing twelve months) deal wins of nearly $100.7 billion as at Q1FY25, up 16.6 per cent year-on-year despite the downturn, (b) stabilised margins, (c) sustained medium to long-term opportunities in digital transformation, especially in Cloud, cybersecurity and Gen AI, (d) enhancing client’s operations across verticals, and (e) potential positive consumer sentiment from expected Fed rate cuts and likely unlocking of client spending," said Nirmal Bang.

The brokerage firm recommends a ‘buy’ on LTIMindtree in tier-1 and Coforge and Birlasoft in tier-2 IT stocks.

Worst over for the IT sector? What IT stocks you should buy

Mint consulted several experts to gather their insights on the IT sector's outlook and recommended stocks to buy. Here's what they said:

Ajit Mishra, SVP of research at Religare Broking

It’s possible to argue that the worst may be behind for IT stocks, and a US Fed rate cut could benefit the sector by easing financial conditions and improving client spending.

After a challenging period marked by global uncertainties, inflation, and reduced IT budgets, signs of stabilisation are emerging.

Demand from sectors like BFSI, healthcare, and digital transformation projects may provide support.

Top picks from the sector include TCS, Infosys, and Birlasoft, which are well-positioned to capitalize on an eventual recovery.

However, growth prospects remain muted in the near term due to cautious client spending and concerns over global recessions.

A full recovery will depend on improved visibility in deal pipelines and overall economic recovery, especially in key markets like the US and Europe.

Manish Chowdhury, the head of research at StoxBox

Chowdhury believes that the worst for the overall IT sector is behind us and the second half of the current financial year (H2FY25) would fare better than the first half of the year (H1FY25) on account of improving demand environment, robust deal wins, easing pressures on the supply side, growing demand for new-age solutions and lower base.

"We sense that most of the negatives in the sector are seemingly priced in, and the expected interest rate cut in the US would further support discretionary spending going ahead. The earnings from the US technology sector continue to support the buoyancy in the overall IT sector," said Chowdhury.

"A tinge of optimism in the recent quarterly management commentaries of Indian IT companies further supports our constructive stance. We believe that a relatively better valuation still provides a good risk-reward opportunity. Investors should accumulate TCS, HCL Technologies, Tech Mahindra and Zensar Technologies from a medium to long-term perspective," said Chowdhury.

CA Vatsal Vinchhi, equity analyst of the IT sector at Choice Equity Broking

IT companies are experiencing a resurgence in demand within the BFSI sector in North America, indicating a promising outlook for FY25E compared to FY24.

This positive trend is partly attributed to a lower base in FY24 and the anticipated interest rate cuts beginning in September 2024, expected to stimulate discretionary spending on IT services.

Additionally, the acceleration of AI-related investments and the growth in TCVs contribute to a robust growth trajectory for IT companies.

"Leading firms such as Infosys, HCL Tech, Coforge, and Persistent Systems are well-positioned to benefit from these trends," said Vinchhi.

Rajesh Sinha, Senior Research Analyst at Bonanza Portfolio

The prospect of a US rate cut will enhance tech spending, particularly in sectors like BFSI, which is crucial for Indian IT companies.

Lower interest rates typically lead to increased tech spending, benefiting Indian IT companies as they derive a substantial portion of their revenue from the US market.

Recent data indicated a rise in consumer confidence in the US, which could signal a healthier economic environment conducive to tech spending.

Despite the positive outlook, concerns regarding potential slowdowns in US economic growth could impact tech spending.

"We believe the immediate outlook for IT stocks is favourable. However, underlying headwinds persist in the US economy, such as household debt hitting record highs of $17 trillion in March 2024, weakening consumer spending, etc.," said Sinha.

"While the Nifty IT index is currently at a record high and supported by rate cut expectation, the long-term outlook will entirely depend on the timing of the rate cut by the Fed and how quickly and to what extent the US economy will revive, and tech spend will increase. We advise investors to increase exposure to IT sector companies like HCL Tech, Birlasoft, Sonata Software, and Mastek for a long-term investment," said Sinha.

Amit Goel, co-founder and chief global strategist at Pace 360

A rate cut could boost IT spending, as businesses may be more inclined to invest in technology to improve efficiency and reduce costs. However, the overall impact on IT stocks will depend on several factors, including the strength of the broader economy and the specific companies involved.

The IT sector is vulnerable to global economic conditions. A significant downturn in the global economy, particularly in key markets like the US and Europe, could impact IT spending and, consequently, stock prices.

The IT industry is highly competitive. Factors like technological advancements, pricing pressures, and changes in client preferences can influence individual companies' performance.

The strength or weakness of the Indian rupee against the US dollar can impact the profitability of IT companies that derive a significant portion of their revenue from overseas markets.

Shrey Jain, the founder and CEO of SAS Online

"We are at a very early age in the AI revolution, and any correction of 10-15 per cent is an opportunity for investors in the mid-to-long-term," said Jain.

Jain pointed out that markets are forward-looking, and IT stocks are recouping from the worst. The upbeat earnings and aggressive AI spending across IT verticals indicate that IT stocks and this space will continue to do well in the long term, with their part and parcel of sideways correction in the short term.

He underscored that the positive trigger for this is the US Fed rate cut, which has been historically good for technology and materials, followed by an un-inversion; technology stocks usually outperform the broader index.

“Any surprise on the inflation front would push the Fed to target a 50 BPS cut before 2024, which could further spark a fresh rally,” said Jain.

Read all market-related news here

Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.