IT index outperforms Nifty in 2024 but is all really well with the sector? Here's what investors should know

livemint.com:

Wipro, TCS, Mphasis, Coforge, and Persistent Systems and an over 40 percent decline at Tech Mahindra doesn’t support sharp recovery hopes as deal durations are rising," said Ambit. The brokerage retains a view of modest growth improvement in FY25E and a fall in Tier-1 margins (contrary to street hopes of increases). It believes that Tier-1/Tier-2 one-year forward P/E premium of 55 percent/116 percent to pre-Covid 3-year average looks unsustainable.

The brokerage pointed out that EBIT margin beats were seen at 5 of 9 companies, but ex-Persistent Systems/LTIMindtree, EBIT margin was still 1-7 percent lower than pre-Covid (Q3FY20) across coverage. Margin beats were driven by the up-fronting of levers (sub-con/staff cuts), which could come back to bite when growth returns. Ambit sees operating leverage getting played out by Q4 itself and headwinds from incremental hiring, wage hikes, and deal dilution in FY25.

Ambit expects the top 4 EBIT margins to decline 50bps to 20.3 percent over FY23-26 (vs 22.2 percent in FY22). The cost of growth needs to be watched on cash flows, wherein FCF (free cash flow) CAGR was lagging EBITDA CAGR over the last 2 years for 5 of 9 coverage companies. As per the brokerage, the narratives on discretionary pick-up seem to have been lapped up even as companies indicated a limited change to client spending behavior.

It believes in a scenario of growth/margins likely below pre-Covid, valuations building a structural uplift in growth are unsustainable. Ambit prefers turnaround plays Tech Mahindra and Cognizant or better segmental skew - HCL Tech. It likes Infosys over TCS on cheaper valuations and risk of growth versus margin trade-off at the latter.