IT sector outlook 2021: High likelihood of Nifty IT underperformance over 2021

Updated : December 18, 2020 03:42 PM IST

The Nifty IT is up over 49 percent YTD and has gained more than 110 percent since its March lows.

According to ICICI Securities, the re-rating in Indian IT hints at much taller expectations versus even global tech.

The year 2020 will go down in the history as a disruptive year for mankind, be it socially, economically or otherwise. It has also underlined the importance of social distancing and technology-driven products, making them a basic necessity. The use of technology became indispensable. This resulted in a huge demand for technology-led companies and as such, triggered a hefty rise in their valuations.

Industry experts and analysts are sounding cautious as they believe it would be the "acid test for the lofty expectations around COVID-led acceleration in cloud / digital adoption and cost savings".

According to ICICI Securities, the re-rating in Indian information technology (IT) hints at much taller expectations versus even global tech. It noted that the global companies which are relatively closer such as Microsoft and Alphabet have seen their stocks largely underperform Indian IT, as the pandemic unfolded.

The Nifty IT is up over 49 percent YTD and has gained more than 110 percent since its March lows.

"We are skeptical on the street's hyperoptimism around COVID-led acceleration in digital / cloud adoption. Weakness in incremental sales/backlog of hyper-scalars, recent moderation in their commentary, stagnancy in As-A-Service deals reported by advisories like ISG and Gartner’s CY21 IT spending outlook underpins our assessment," ICICI Securities said in a report.

As the physical activity across most economies and industries is already reverting to pre-Covid baseline levels, the brokerage expects IT spends to be lower than usual in 2021. The progress on inoculation over 2021 should further accelerate the reversion of traffic from digital to physical channels.

Additionally, deferrals of wage hikes, absence of travel costs and marketing events were the biggest margin tailwinds for IT companies over 9MCY20. However, the travel and marketing events are likely to meaningfully resume before September 2021.

In addition, restarting of marketing events and potentially weaker dollar are key margin headwinds to look out for, the report said.

Going ahead, ICICI Securities sees a high likelihood of Nifty IT underperformance over 2021.

"Some of the one-time and technical factors which partly aided the sector's massive re-rating / outperformance over 2020 will cease to be relevant in 2021. Potentially, the last leg of surprise related to COVID 'comeback' should come in December 2020 earnings. Current relative valuations of Indian IT (vs global tech) will present a more compelling investment case in the latter, especially for FIIs," it said.

The brokerage house remains cautious and selective on IT sector preferring stocks with scope for idiosyncratic surprises and valuation comfort. Among IT stocks, the brokerage picks Infosys, HCL Technologies, Mphasis and Mindtree.

IT sector outlook 2021: High likelihood of Nifty IT underperformance over 2021

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