TCS, HCLTech Downgraded To 'Sell' On Expensive Valuations: CLSA

CLSA India Pvt. downgraded Tata Consultancy Services Ltd. and HCL Technologies Ltd. on expensive valuations, saying the growth outlook remains weak at best for the information technology sector.

"We see more downside risk to our FY25CL estimates," the research firm said in a note on Tuesday.

CLSA downgraded TCS and HCLTech to 'sell' from 'underperform'. It reiterated a 'sell' on Wipro Ltd. and LTIMindtree Ltd.

"We believe (the) mid-single-digit revenue-growth guidance by HCL Technologies and Infosys in April 2024 would be a negative catalyst for Tata Consultancy Services, HCL Technologies and Wipro (all 'sell' rated)," it said.

The NSE Nifty IT index is up 23% since Nov. 10 and has outperformed the Nifty 50 by 10 percentage points due to softening of the U.S. bond yields, improving demand commentary by hyper-scalers and the hype around generative artificial intelligence and the Nvidia rally, according to CLSA.

The percolating impact of these tailwinds fail to reflect in various IT services companies' 2024 revenue-growth guidance and the growth outlook for banking, retail and telecom verticals, it said.

The 2024 outlook for ordering activity from both Information Services Group and Gartner's IT services forecast are reminiscent of what was observed in 2019. The Nifty IT's 12-month forward valuation stands at 28 times, marking a deviation of 1.3 times the standard deviations above its average over the past six years, which has been 22 times, the note said.

• "We do not change our estimates, investment thesis or target price for TCS, but we downgrade it from an 'underperform' to a 'sell' rating as we believe its valuation has exceeded the fundamentals".

• A delay in the revival of discretionary spending due to sticky inflation and persistently high interest rates.

• An increase in competition for cost-optimisation projects with renewed rigour from IBM and Cognizant Technology Solutions Corp,

• Increased risk from insourcing with captives growing faster than third-party IT service companies in India.

• A potential benefit from Gen AI around both productivity and revenue generation still remain 12–24 months away,

• Election-related uncertainty in both the US and the UK, which together contributes 60% of demand for major Indian IT companies.

• HCLTech is trading at an all-time high multiple, which CLSA said could normalise going into the weak seasonality of the fourth quarter and the first quarter of the next fiscal.

• Given its lower exposure to discretionary spending relative to Infosys, any revival in macro may not reflect in HCLTech's revenue growth.

• "We are not changing our estimates, target price or investment thesis for HCLTech, but downgrade it to 'sell' from 'underperform' due to expensive valuations," CLSA said.

• Due to the weak seasonality, it expects the stock to correct on both absolute and relative to the sector.

• Wipro's organic-growth prospects remain the weakest in CLSA's coverage universe, which fails to reflect in current multiples. The research firm maintains a 'sell' rating on the stock.

• CLSA maintains 'outperform' rating on Tech Mahindra Ltd. due to structural-turnaround potential under the new management.

• LTIMindtree Ltd.'s valuations have been range bound for the last one–two years, potentially capturing downside risks to potential revenue and cost synergies from the LTI and Mindtree merger. "We maintain our 'sell' rating."

• AI-led rally in the Nasdaq stocks has been one of the factors driving the outperformance of the Nifty IT over the Nifty.

• U.S. bond yields may remain sticky if high inflationary pressure persists in the U.S. on a tight labour market and continued strong consumer demand.

• High level of uncertainty in 2024 leading to a soft revenue-growth guidance by key players in the technology space