Among individual stocks, Morgan Stanley has maintained their overweight rating on HCLT, LTIMindtree and Infosys within the large-caps.
Morgan Stanley has increased the target prices of certain information technology (IT) stocks by as much as 29 per cent, anticipating an improvement in earnings in the near future.
Within the IT and engineering research and development (ER&D) services sector, it is now more optimistic about growth and margin estimates for 2024-25 (FY25).
In a recent report, analysts at Morgan Stanley wrote in a recent report that, along with the stabilisation of macroeconomic risks, the conversion of pipeline projects into the order book (evidenced by numerous significant deal announcements) and commentary on the discretionary spending environment, though weak, not deteriorating further, point towards improved growth trends.
They believe that margins have more tailwinds in FY25, including falling attrition rates, suboptimal utilisation rates, room to improve the employee pyramid, and operating leverage.
Within largecaps, employee and subcontracting costs as a percentage of revenues have the biggest room for improvement for HCLTech and Tata Consultancy Services (TCS), according to Morgan Stanley.
Analysts Gaurav Rateria and Sulabh Govila of Morgan Stanley noted in a recent report, “We have revised our price targets up by 11-29 per cent, led by roll forward, lower probability of bear case, higher probability of bull case, and increased long-term earnings.
"We maintain our higher-than-consensus double-digit revenue growth for FY25E, while we lift margin assumptions for ER&D names owing to potential price increases and better operating leverage.”
Regarding individual stocks, Morgan Stanley has retained an ‘overweight’ rating on HCLTech, LTIMindtree, and Infosys within the largecap segment.
Rateria and Govila added, “We upgrade Cyient (within ER&D services) to ‘overweight’ due to increased earnings and higher multiples, with the revenue growth cycle remaining strong.”
Valuations
On the stock market, the National Stock Exchange Nifty IT Index has outperformed, showing a gain of over 13 per cent in calendar year 2023, compared to an 8.5 per cent increase in the Nifty50.
According to ACE Equity data, Persistent Systems, Coforge, L&T Technology Services, Tech Mahindra, Mphasis, LTIMindtree, and HCLTech have been among the top performers during this period, surging by 21 per cent to 52 per cent.
Morgan Stanley believes that the sector’s future performance will align with the overall market sentiment.
Relative valuations are not as favourable as the top four Indian IT stocks, with a 19 per cent premium to the S&P BSE Sensex compared to the long-term average of 4 per cent.
Even when compared to global peers like Accenture, Morgan Stanley noted that TCS’ price-to-earnings ratio is at a premium of 4 per cent.
“Foreign institutional investors and domestic institutional investors both have an underweight position in IT stocks.
"This has come down versus the past, but there is still more room to close, which would support current valuations,” the report stated.
Revenue boost
In the 2023-24 (FY24) July-September quarter, it anticipates quarter-on-quarter revenue growth to improve for IT services companies, given strong order bookings during the quarter.
This supports expectations of stronger growth in the second half of FY24.
“While we are getting more constructive on growth, we still maintain an in-line view on the industry, as the sector has become relatively more expensive in the past few months.
"The premium to Sensex has increased, and we still don’t see consensus raising F24/F25 earnings-per-share assumptions.
"Due to this, we have been selective in our stock picks,” Morgan Stanley observed.
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