Are IT stocks a good contrarion bet?

With a change in investor preference to cyclical stocks like those of capital goods, infrastructure and automobile firms, the defensives, especially the IT pack, have taken a back seat, note Puneet Wadhwa and Deepak Korgaonkar

Until some time ago, information technology firms’ stocks were considered safe for investors, given the market volatility due to a weak economic outlook and the rupee-dollar equation.

But the tables have turned lately.

With a change in investor preference to cyclical stocks like those of capital goods, infrastructure and automobile firms, the defensives, especially the IT pack, have taken a back seat.

Cyclicals are sought after because these firms could be key beneficiaries of a demand pick-up as a new government takes charge at the Centre and effects reforms.

The BSE IT index last week saw its sharpest weekly fall in eleven months.

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On Wednesday, it slipped over 2.6 per cent in intra-day trading before settling 2.2 per cent lower than previous close at 8,668 -- the lowest level in the past three months.

“Wednesday’s fall in IT stocks was triggered by TCS’ (Tata Consultancy Services’) interaction with analysts on the outlook for the fourth quarter and 2014-15. Its guidance is probably not what the market was expecting,” said R Sreesankar, head (institutional equities), Prabhudas Lilladher.

IT stocks’ fall of the past few sessions only got pushed as the country’s second-largest software services firm, Infosys Technologies, said it might only be able to meet the lower end of its revenue guidance for 2013-14, suggesting a near-flat to a small revenue decline on a sequential basis in the January-March quarter.

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Infosys now expects full 2013-14 revenue growth to be at the lower end of the guided band of 11.5-12 per cent.

It has cited weak client spending in the manufacturing and retail & CPG (consumer packaged foods) verticals for weak performance.

Projects were delayed and, in some cases, cancelled by clients because of the change in investment priorities, Infosys said.

In another letdown, TCS on Tuesday said it expected 2014-15 to be a better, but the company’s performance in the fourth quarter of this financial year would be weak, with 40-50-basis-point lower margins.

TCS expects its domestic (India) business to remain weak due to coming general elections.

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So, given the recent fall in most IT stocks, do these make for a good contrarian bet, especially at a time when the focus is on riskier bets against the backdrop of the election outcome?

Some analysts believe so.

Prabhudas Lilladher’s Sreesankar says: “Investors are rebalancing their portfolios, probably in anticipation of a stable central government after the coming elections.

“The money has moved from defensive plays to the cyclicals like capital goods and infrastructure.

“The rupee has also slightly strengthened, impacting sentiment. We remain overweight on the IT sector.

“Among stocks, we remain overweight on Infosys, Tech Mahindra and Wipro and have an accumulate rating on TCS.”

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Vaibhav Sanghavi, director (equities) at Ambit Investment Advisors also believes a strengthening of the Indian currency and a guidance downtick by Infosys and TCS have impacted sentiment. But he expects an improvement.

“Going ahead, the business growth, barring a couple of quarters, is likely to resume for most IT companies, as recovery picks up in Europe and the US.

“We will see an increase in IT spending from both these geographies.

“Apart from the short-term blip we see in terms of sentiment and guidance, it is a good opportunity for investors to buy IT stocks on a decline,” he says.

As regards TCS, analysts at Nirmal Bang have lowered their earnings per share estimates for 2014-15 and 2015-16 by around two per cent and one per cent, respectively, factoring in a likely lower revenue growth in the fourth quarter of this financial year.

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But they have upgraded the rating on TCS to ‘buy’ (from ‘hold’ earlier).

“We expect 2014-15 to be a strong year and believe TCS will continue to post consistent industry-leading growth numbers.

“However, we have reduced our target price on TCS to Rs 2,557 (from Rs 2,590 earlier), owing to a reduction in EPS estimates,” they said in a client note.

Ashwin Mehta and Pinku Pappan of Nomura suggest in a note: “After the recent disappointment at Infosys, with the company guiding for a moderation in growth outlook, we believe TCS’ outlook of no cancellations/ramp-downs, no vertical-specific weakness and better discretionary outlook for 2014-15 reinforces our confidence in the underlying demand trends in the sector remaining strong.

“HCL Technologies, TCS and Tech Mahindra, followed by Infosys, remain our pecking order of preference within the sector.”