JP Morgan relegates Indian IT sector to underweight

JP Morgan has downgraded the Indian Information Technology (IT) sector to ‘underweight’ as it believes the high-point of the sector is over.

Ankur Rudra and Bhavik Mehta of JP Morgan said that rising margin headwinds in the near-term and the revenue headwinds in the medium-term from a potential macro slowdown will mean that the sector’s earnings upgrade cycle is behind.

“Sector reverse DCFs suggest that the market is still baking in 6 – 13 per cent growth for Tier 1 companies and 14 – 33 per cent for midcaps over the next decade, which seems optimistic,” Rudra and Mehta said. JP Morgan believes that the Indian IT stocks are the most expensive globally and are at a premium to digital native peers and Accenture, and at par with enterprise software that appears unsustainable.

JP Morgan said growth in the Indian IT sector was accelerating till the third quarter of 2022 (Q3-22) and slowed starting the fourth quarter of 2022 (Q4-22), which it believes will only worsen in fiscal 2022-23 (FY23) from tougher competition, supply-related issues and a worsening macro situation.

JP Morgan analysts say, “We expect margin headwinds to drive downgrades in Q1/Q2-FY23 earnings season, and macro-led revenue downgrades in Q3/Q4, that make even current multiples sustainable for some. While USD/INR has depreciated 3 per cent in the quarter, adverse forex markets have nullified any margin gains.”