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The Covid-19 induced work from home culture brought many tailwinds for the Indian IT service sector. The increased thrust on digital transformation and cloud adoption aided an impressive earnings growth, fuelling a sharp rally in IT stocks. The Nifty IT index is among the top performing sectoral indices on the NSE. In fact, over the last year, the Nifty IT index has rallied 88.29% versus 53.83% rise in the Nifty 50 index.

Despite the ongoing rally the sector is poised for a re-rating in the near to medium term.

Market share gains

Driven by a surge in demand and lack of global, diversified and quality IT vendors, Indian IT companies will continue to gain market share. Phillip Capital expect this to be boosted by the confusion caused in the global IT landscape by IBM, DXC and Cognizant and by the gradual shift to the outsourcing model from captive one.

Party to continue

As per Gartner, while the global, IT services market saw 3.2% CAGR (compounded annual growth rate) in the last decade, Indian IT exports saw 9.7% (Nasscom). Over the next five years, Gartner expects global IT services spending CAGR at 9%. “Even if Indian IT companies maintain the same outperformance gap, mid-teen growth is a given for the industry for the new few years,” noted Phillip Capital in a report.

Deal wins

Deal wins remain strong across large & mid-sized players after the industry recovered smartly from covid induced shocks in Q1FY21. While large players have won large lift and shift cloud migration deals, midcap have also started tapping the large deals market. ISG continues to forecast the deal-flow momentum to continue.

Pricing power

Management commentaries across large & midcap players suggest some sort of pricing power has come back to the IT-services industry, at least for niche skills. “A first in almost a decade, and could provide an additional fillip to the industry’s growth trajectory – something that nobody is factoring in, even now,” the report stated.

New avenues

Phillip Capital has always been highly positive on Europe for its potential untapped opportunity for Indian IT-services companies. The pandemic has preponed this opportunity by a few years, as it made EU clients realize the value proposition that India IT services companies provide in terms of business continuity, ability to migrate to new platforms, and their high service standards.

Easing supply-side challenges

Accelerated demand for IT services globally, has led to an unprecedented software talent crunch in India, leading to exceptional salary hikes & drops in margins for companies. Phillip Capital is of the opinion that the pressure should ease considerably by H2FY23 on the huge supply of engineering talent in India and decreasing correlation between revenue and employee growth.

Outlook

Phillip Capital believes that current valuations will sustain driven by liquidity along with factors like TINA (there is no alternative) and FOMO (fear of missing out). Also, with pricing power returning, the IT-services sector is closing in on FMCG fundamentals. “Midcap will continue to trade at a premium to largecaps in the near to medium term, driven by a never before outperformance in revenue growth versus largecaps for at least the next two years,” the report added.

The brokerage firm is having a buy rating on TCS (price target Rs 4,430), Infosys (price target Rs 1,900) in the largecap IT space. Whereas within the midcap space it is bullish on stocks like Mindtree (price target Rs 4,330), Coforge (price target Rs 6,510), Mphasis (price target Rs 3,620) & KPIT Tech (price target Rs 420).

(Disclaimer: The recommendations in this story are by the respective research and brokerage firm. Money9 & its management do not bear any responsibility for their investment advice. Please consult your investment advisor before investing.)