Indian IT’s unlikely to escape the US tech storm

Although shares of technology service providers have fallen less than the global and local technology giants, analysts said they will be vulnerable to further downsides as the likelihood of further earnings downgrades could make valuations look still expensive.

Shares of domestic technology services providers are down 16-35% from their 52-week highs. The Nifty IT index and the Nasdaq 100 index in the US have declined 23% each from their respective 52-week highs. Almost half of the technology-laden Nasdaq 100 stocks have fallen between 30% and 75% from their 52-week highs. Nearly 15% have lost more than half their value, the worst such ratio since the financial crisis in 2008.

The recently-listed new-age tech stocks such as Paytm, Zomato, and Nykaa have dropped 40%-71%. A section of the market, however, argues India’s technology service providers must not be clubbed with global technology giants such as Amazon and Facebook because of different business and valuation models. However, their close links to events in the US lead to comparisons.

Many market participants liken the ongoing sell-off in shares of many of the US-based technology companies to the dot-com bust in the early 2000s. A recent Bank of America fund managers’ survey shows they are underweight on every US tech stock for the first time since December 2008.

“Currently, the Nifty IT index is trading at a near 13% premium to the US NDXT (Nasdaq 100 Technology Sector) index, showing resilience in the domestic IT sector, driven by the robust deal pipelines and continued momentum in digital transformations along with the support from positive currency movements,” said Sethumadhavan KS, an analyst at Geojit Financial Services. “We expect range-bound movements for the sector over the medium term.”

Concerns over expensive valuations are higher in smaller domestic software exporters.

Indian Tier-2 information technology companies are now trading at a price-to-earnings (PE) premium of 40% compared to the blue chips, as against a discount of 14% on January 1, 2020.

“We fear Indian Tier-2 IT companies would suffer more because of vendor consolidation under the pressured profit picture for customers, a less diversified revenue mix which could throw up negative growth surprises, and a larger exposure to non-Global 1000 clientele whose profits are more vulnerable in the current macro environment,” said Girish Pai, head of research, Nirmal Bang Equities.

India’s largest software exporter Tata Consultancy has corrected 16% from its yearly highs but is trading at a PE of 33.40 times as against its five-year average of 27.91 times. Infosys trades at a PE of 29 times compared with five year-average PE of 22. The stock has declined 20% from its 52-week high.

“PE multiples have peaked in the current cycle, and while they have corrected a bit recently, they are still at elevated levels and will compress as interest rates in the US head higher, and liquidity conditions tighten,” said Pai.