Why bad results for Alphabet and Microsoft is bad news for India’s IT sector as well

As the American tech giants face the heat, the Indian IT sector — which depends to a large extent on business and revenue from the US and other developed economies — is unlikely to go unscathed. North American and European markets account for over 80 per cent of revenues of TCS and Infosys.

What is hurting the IT sector?

High inflation and sharp rate hikes have weakened the growth outlook of the US economy and forced companies to reduce their IT budgets amid talk of a coming recession. Rising prices and interest rates have increased the cost of capital for American companies and eaten into disposable incomes of individuals, forcing them to cut spending. This has directly impacted the tech companies in regard to their products, services, and ad revenues. An adverse macroeconomic situation in the US and Europe will keep order flows, business growth, and revenue and share prices of Indian IT majors on a leash.

How have Indian firms done?

TCS and Infosys, the two leading Indian IT companies, posted strong results for the quarter ended September. TCS announced a net profit of Rs 10,431 crore for the quarter, an 8.4 per cent year-on-year increase; Infosys reported a consolidated net profit of Rs 6,021 crore, an 11 per cent jump.

However, analysts say that since the IT companies are largely dependent on the US and Europe for business and revenues, they are likely to face pressure. While India is seen as being relatively well placed amid the current global economic turmoil, the IT sector may be hit due to stronger global linkages.

How have IT stocks fared?

The stock market performance of the IT companies reflects these concerns. Between April 1 and October 27, the benchmark Sensex at the BSE has risen 2 per cent — however, the IT index has fallen 20 per cent during this period. TCS (–15%), Infosys (– 20%), and HCL Technologies (–11.7%) shares have taken a beating.

Over the last six months, mutual funds have significantly reduced their holding of software stocks. At the end of March, MFs had 13 per cent of their equity AUM in IT stocks; by September, this figure had been more than halved to 6.17 per cent.

In absolute terms, the MF holding of software stocks has come down from Rs 2,62,314 crore in March to Rs 1,27,492 crore in September.

TCS unveiled a Rs 18,000 crore share buyback in March; Infosys recently announced a buyback worth Rs 9,300 crore.

What is the sectoral outlook?

Valuations of IT and technology companies rose sharply during the Covid-19 pandemic, riding the all-round digital surge, and optimism about their growth. Many observers feel that their price-to-earnings ratio, which jumped from around 16 to 30 in 2021, is set to witness a correction.

“During Covid times there was an urgency to adopt digital, and that led to higher growth expectations, and valuations of IT companies rose sharply. Now growth is coming down and the risk is that if the US slows down and the rising cost of capital eats into companies’ profitability, the demand outlook will weaken and put valuations under further pressure,” a CIO of a leading mutual fund said.

Analysts feel that valuations could see corrections if companies see a decline in order bookings in any one quarter.