Why HSBC Upgraded TCS And Downgraded Infosys Post Q3 Results

Revenue growth was slightly better in third quarter for information technology companies, likely due to lower-than-expected furloughs and higher pass-through revenues for large top-tier IT companies, as margins improved, beating estimates, HSBC Global Research said.

The firm noted, however, that margins missed estimates for mid-tier companies.

Third quarter results were a roller coaster for IT companies. It began with an unexpected beat from top-tier companies like Tata Consultancy Services Ltd., Infosys Ltd., HCL Technologies Ltd., and even Wipro Ltd., although on undemanding consensus expectations, the research firm said in a Feb. 6 note.

However, the exuberance wasn’t sustained as Tech Mahindra Ltd., LTIMindtree Ltd., Mphasis Ltd. and Coforge Ltd. reported misses (either revenues or margins) with muted outlook, HSBC said.

The research firm upgraded TCS to 'buy' rating and cut Infosys' rating to 'hold'.

"We prefer TCS; we think it is the least volatile business and stock in the sector. Regarding Infosys, we still expect some normalisation of growth, though market expectations run high for FY25. Additionally, the margin outlook and large deal ramp-ups concern us," it said.

Despite Infosys’ underperformance last year, HSBC remained constructive through 2023 due to a likely business normalisation and valuation gap with TCS.

"However, the valuation gap for TCS has now come down to only c10%, and the near-term growth and margin outlook for TCS seem better, in our view (thanks to the recent large deal wins)," it said.

After an extraordinary outer performance by mid-tier IT companies in the past two to three years (post Covid-19), there has been quick normalisation, according to HSBC. In line with the pre-Covid-19 behaviour, as demand has softened, mid-tier IT services have begun to struggle on profitability.

"We think this pressure may remain in the short term until demand picks-up meaningfully, which is unlikely, in our view," the note said.

HSBC Global Research continues to prefer top-tier IT and mid-tier specialised ER&D players in 2024 over mid-tier IT services players.

Barring a few optimistic comments from TCS and Wipro, most companies were broadly non-committal on the FY25 demand outlook.

The third quarter marked the bottom of the slowdown, and stocks reacted to that positively, according to HSBC. "However, for stocks to perform consistently from the current levels, we see the extent of pick-up in FY25 as key."

Most other sectors, like manufacturing, healthcare, and energy, performed reasonable. The pick-up in FY25 is highly contingent on banking and retail. Turning to financial results and commentary from large banks HSBC is not optimistic for a major surge in spend by banks. Hence, the growth forecast for FY25 remains in the range of 6–7%.

Shares of TCS jumped as much as 4.07% to hit a record high price of Rs 4,135 apiece, before paring gains to trade 2.61% higher at 11:03 a.m. This compares to a 0.33% advance in the NSE Nifty 50.

The stock price was trading close to its buyback price of Rs 4,150. The buyback ended on Dec. 7, 2023.

Of the 44 analysts tracking the company, 23 maintain a 'buy', 11 recommend a 'hold,' and 10 suggest a 'sell', according to Bloomberg data. The average 12-month analysts' consensus price target implies a downside of 2.6%.