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What to expect from IT stocks after worst day for TCS, Nifty IT in months

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TCS kicked off the earnings season last week with profit, revenue, EBIT and margin falling short of the Street estimates.

What to expect from IT stocks after worst day for TCS, Nifty IT in months
A gravity-defying rally in IT stocks came to a sudden stop on Monday. The worst day for TCS shares in 18 months also turned out to be the worst for the Nifty IT index in 11. Reason? Dalal Street was reacting to quarterly numbers of India's largest IT services provider.
TCS shares fell 6.3 percent on October 11 in their worst single-day fall since March 23, 2020, pulling the Nifty IT gauge 3.4 percent lower -- its worst day since November 10, 2020. While all 10 stocks in the pack ended lower, Infosys, HCL Tech and Wipro dragged the index the most.
TCS kicked off the earnings season last week with profit, revenue, EBIT and margin falling short of the Street estimates. Infosys, Wipro and HCL Tech will post their financial results for Q2 this week.
The dramatic halt comes amid stretched, if not overblown, valuations in the IT gauge, which has risen 58.5 percent in the past one year to easily beat the Nifty50's 50.4 percent.
Here's how the Nifty IT members have fared in the last one year:
StockReturn in past one year (%)P/E
L&T Tech187.664.1
Mindtree184.256.8
Mphasis124.447.7
Coforge117.4107.2
L&T Infotech100.852.2
Wipro75.637
Tech Mahindra63.931
Infosys52.838.4
HCL Tech52.339
TCS3138
What has powered the surge in IT stocks?
The coronavirus crisis has turned the once defensive IT sector of Indian market into a major driving force. Until a few years ago, IT was considered as an export-driven, value-oriented defensive sector in the country, with tech giants such as TCS, Infosys, Wipro and HCL Tech well-known for their ability to generate free cash flows, according to brokerage Ventura Securities.
IT earnings have seen "an impressive jump" over the last 6-8 quarters, making the market performance of the space equally impressive. Shares of companies expected to declare impressive earnings in Q2 have rallied the most, and witnessed massive PE expansion already, according to Ventura.
What experts say about IT sector after TCS earnings
AK Prabhakar, Head of Research at IDBI Capital, told CNBCTV18.com that though the quarterly performance of TCS was "slightly disappointing, everything is priced in for the stock".
Describing TCS as a "multi-year growth story", Prabhakar said the company's prospects are intact from a long-term view. "The company is still growing at a CAGR of 15 percent, which means sales and profit should double in five years," he added.
Many others are not so optimistic.
Sanjeev Prasad, MD and Co-Head of Kotak Institutional Equities, said the company's earnings were disappointing for sure as Street was expecting much higher numbers.
"It seems like company is struggling for volumes currently whereas the rest of the industry seems to be in somewhat better position. Now whether it is an issue specific to TCS is something we will find out in next few days, but at least in our assessment, it is more like a TCS-specific issue for now. Clearly it doesn't set the tone well for the rest of the IT sector,” he said in an interview to CNBC-TV18.
The IT sector is pricing in a lot of strong, stable margins and TCS has disappointed on both fronts. "It is becoming really hard to justify the valuation the sector is trading at now," he said.
Hemang Jani, Head - Equity Strategy, Broking and Distribution at Motilal Oswal Financial Services, told CNBC-TV18 the market seems to be "a little worried about this 80 bps miss on the revenue, and 60 bps miss on the margins for TCS".
Jani continues to have an overall positive bias on the IT major. "Of course, there could be few days of underperformance, because of this number," he said.
In the current environment, there is "definitely an appetite for some of the largecap IT names given that they anyway have underperformed the midcap companies and the overall comfort is very high", he said.
Where to now?
Ventura Securities' Head of Research, Vinit Bolinjkar believes a rerating is unlikely for IT names going forward.
Much of IT sector growth expectations for the next 3-5 years are already factored into stock prices, said Bolinjkar.
His top largecap bets are TCS and Infosys given their digital revenue leadership and Cloud-based solutions. From the midcap basket, he is bullish on Mphasis.
Ventura expects IT stock movements likely to be largely on earnings performance. Stocks languishing after earnings despite a good show will be "perhaps a sign of tiring bulls", it added.
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