HCL Tech To Cyient: Indian IT Services Growth Will Surprise In FY25, Says Morgan Stanley

Revenue growth of Indian IT services and engineering research and development companies may surprise positively in fiscal 2025 despite a weak discretionary spending outlook, according to Morgan Stanley.

"Despite a weak discretionary spend outlook, we still believe FY25e revenue growth could surprise positively vs. consensus estimates," the brokerage said. "We are 1-3.9% ahead of consensus on our FY25e revenue growth outlook for most of the stocks under our coverage."

The brokerage maintains higher-than-consensus double-digit revenue growth estimates for FY25e and lift margin assumptions for ER&D names, owing to potential price increases and better operating leverage.

Stabilising macro-risks, converting pipelines into order books—reflected in multiple large deal announcements—and the commentary of the discretionary spend environment being weak but not deteriorating further point to improving growth trends for the future, according to Morgan Stanley.

"For IT Services, we have tweaked our margin assumptions, that is, expectations of improvement now in F25 compared with those in 2HF24, given changes in the mix of business towards cost optimisation, which could have a near-term drag on margins," it said in a Sept. 26 note

Morgan Stanley increased the price targets for the coverage companies due to:

• Rolls forward scenario values by six months to Sept. 25 (driving a 5-6% increase);

• Lowers the probability of its bear case to 20% from 30% and increases its bull case to 20% from 10% in many cases; and

• Raises its long-term earnings assumptions in some cases.

Though Morgan Stanley is getting more bullish on growth, it continues to maintain an in-line view of the industry. This is because the sector has become relatively more expensive in the last few months—its premium to Sensex has increased. The brokerage also doesn't see a consensus on raising F24/F25 earnings per share.

Revising Ratings And Price Targets

• The brokerage has been selective in its stock picks. It maintains an 'overweight' on HCL Technologies Ltd., LTIMindtree Ltd., and Infosys Ltd., within the large caps.

• Morgan Stanley upgraded Cyient Ltd. (within ER&D services) to 'overweight', owing to increased earnings and higher multiples, with the revenue growth cycle remaining strong.

• Maintains 'underweight' on Wipro Ltd. on low valuation and less confidence on revenue growth gap narrowing versus peers.

• Downgrades Tech Mahindra Ltd. to 'underweight' on strong rally, despite cut in earnings, making valuation more expensive. Low confidence in the growth revival in the telecom vertical and potential turnaround due to management changes well in the price

• Morgan Stanley maintains "equal weight" on Tata Consultancy Services Ltd. and MphasiS Ltd. on valuations, despite strong order books and growth bottoming out on a quarter-on-quarter basis.

• Within ER&D Services, Morgan Stanley maintains 'underweight' on Tata Elxsi (India) Ltd. as it expects growth to be suboptimal and high valuations.

• It is also "underweight" on L&T Technology Services Ltd., on low confidence in organic revenue growth guidance of 10% year-on-year in FY24 improving and strong recent outperformance.

Tech Mahindra

• Downgraded to 'underweight' as the revenue growth outlook for the near term remains murky for the company, given it has the highest exposure to the telecom vertical, which will take time to recover, the brokerage said.

• "Hence, we expect Tech Mahindra's revenue growth to recover with a lag relative to peers," Morgan Stanley said.

• The stock has seen a strong rally (+29% year-to-date versus Nifty IT +14.5%), despite a cut in earnings, making valuation more expensive. While a potential turnaround due to management changes appears to be in the price, the note said.

Cyient

• Morgan Stanley upgrades the stock to 'overweight'.

• "We think the EPS upgrade cycle will continue for Cyient, driven by margin expansion, with most ER&D companies potentially getting price increases as per our channel checks, which drives strong operating leverage," the note said.

• The stock has done well year-to-date and is trading at premium valuations compared to its own history, but with improved execution, the re-rating should continue and drive stock performance from hereon as well, Morgan Stanley noted.

Morgan Stanley expects quarter-on-quarter revenue growth to improve for IT services companies in the second quarter, with strong order booking during the quarter, thereby supporting expectations of better growth in the second half.

• It expects HCL Technologies to maintain its revenue and margin guidance for FY24, with a strong order book number in Q2 and an outlook for stronger 3Q/4Q versus 1H.

• "For LTIM we expect improved growth in 2Q vs. 1Q and commentary on improving growth trends in key verticals such as BFSI and Hi Tech in 3Q/4Q," the note said.

• For Infosys, Morgan Stanley expects Q2 revenue growth to be weak but expects the company to maintain guidance for FY24, with stronger commentary for Q4 revenue growth.

• "For Wipro, we expect a weaker revenue growth outlook for 3QFY24 vs. consensus estimates of a positive growth QoQ," the brokerage said.

• For Tech Mahindra (underweight), the brokerage expects a gradual improvement in margin trajectory, along with weak revenue growth and weak order intake trends.