Citi Research remains cautious on information and technology even as large-cap stocks are up 5–10% over the last few days after the sector's top companies reported their earnings.
The management comments have been balanced and consistent, but words like "pent-up" and "green shoots" have created optimism among investors. Headcount reductions continue, and the trends of total contract value for deals are moderate, pointing to a gradual recovery, which is Citi's base case.
Sentiment has moved from pessimistic to euphoric in certain areas, leading to valuations above three standard deviations above the mean, especially when compared to the pre-pandemic five-year period, the research firm said in a note on Monday.
Citi continues to prefer Infosys Ltd. over HCL Technologies Ltd. "Our view remains unchanged that demand has likely bottomed out, but debate is on the pace of recovery; we expect a slow recovery."
It sees risks of derating as there is further clarity on the pace of recovery—gradual and moderate—and limited margin levers in the next financial year.
Positive Management Commentary
Citi sees the commentary as balanced and consistent. Tata Consultancy Services' usage of "pent-up" was in the context of clients being cautious on investments, which possibly creates a pent-up demand when clients start spending once macro-risks recede.
Infosys and HCLTech's comments were in sync with what they have suggested in the past month—unchanged for Infosys to some improvement in engineering, research and development and not all discretionary spend for HCLTech.
Wipro's comments were that the market has not fundamentally changed, but it saw double-digit order-booking growth in Capco. It was surprising that the headcount was lowered again ahead of short-cycle projects ramping up and the fourth-quarter guidance also being weaker than most expectations.
Forward-Looking Indicators
The four companies did beat expectations this quarter, but the guidance has not really changed much. Headcount addition remains muted in the third quarter, according to Citi.
It underscored that there is a disconnect between deal TCV and growth, given the changing nature of deals—average duration has increased in its view—and disclosure between new and renew.
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