IT sector review for the fourth quarter: Axis recommends the purchase of Persistent Systems, KPIT Tech after March quarter results – here’s why

The Indian IT services industry faces near-term challenges due to the economic slowdown and weaker macroeconomic outlook. However, the long-term outlook remains solid and the economy is showing signs of recovery. In a recent Q4 review note, brokerage Axis Securities said it believes the recovery will begin early in the new year, with FY25 showing strong revenue growth.

“After strong revenue growth in FY22 and FY23, we believe IT services may face demand and margin challenges due to economic slowdown and macroeconomic uncertainty. We are skeptical about the short-term prospects due to delayed decision-making regarding automation, the broker said.

However, he further noted that deal wins have remained sustainable even in difficult times, giving confidence that automation spending will rebound strongly over the next few quarters. Demand in industries such as retail and manufacturing remains strong and is expected to increase again in the near future.

The brokerage continues to believe that most IT services companies will regain momentum within a few quarters as deal wins continue to sustain and supply-side challenges ease. The Federal Reserve’s dovish stance could boost the North American macroeconomy, which could increase demand for automation spending. After the fourth quarter results, the brokerage house recommended 2 shares in the IT space – Persistent Systems and KPIT Technologies.

But first, let’s look at some key takeaways from Q4 results.

Income

The brokerage noted that most IT companies reported disappointing revenue growth in Q4FY24, reflecting pent-up demand from major global economies. The Indian IT services sector does not expect a quick recovery in discretionary spending due to persistent macroeconomic uncertainty. He noted that North American revenue growth for Tier 1 technology companies continues to lag behind Europe.

The BFSI sector witnessed moderate growth, with no immediate improvement in discretionary spending, although some improvement is expected in FY25. Industries such as telecom and hi-tech are also struggling to show strong growth. The outlook remains challenging as many IT services companies lack near-term predictability, the brokerage said.

Margin

According to the brokerage, Q4FY24 margin was mixed despite reduced supply-side constraints. Among Tier 1 technology companies, TCS and Wipro showed good results and margin expansion for the quarter. TechM margins began to recover from previously unsustainably low levels. Most of the Tier 1 technologies, except Infosys and TechM (due to ongoing significant restructuring), managed to marginally improve margins in FY25 despite weak revenue growth, driven by strict cost optimization, including lower subcontracting expenses, it said.

On the other hand, for Tier 2 technology companies that previously excelled in defending or improving margins in FY20-23 on the back of excellent growth, margins came under little pressure in FY24. Companies such as Persistent saw their margins shrink year-on-year despite benefiting from one-time changes, the brokerage further said.

Meanwhile, mid-cap IT services companies and Tier 2 IT services companies, which showed relative margin resilience in FY21-23, felt the impact of slowing growth in FY24. Only a moderate recovery is expected in FY25, leading to preferring a tactical approach for TechM among Tier 1 technologies and KPIT, Zensar and Firstsource among Tier 2 technologies, recommends.

The hand wins

Despite continued uncertainty, winning trades remained sustainable. Demand for newer technologies such as artificial intelligence, cloud transformation, data analytics and IoT remains strong, with most companies transacting at an all-time high. This means that when macroeconomic factors turn positive, there will likely be a strong V-shaped recovery, he said.

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Durable systems: The brokerage house issued a call for shares with a target price of ₹4,350, representing a potential increase of over 24 percent.

Persistent Systems’ continued growth, as brokerage Axis Securities highlights, continues in challenging times, driven by greater customer engagement. In Q4FY24, total contract value (TCV) remained strong, reaching a total of $447 million in deal wins. Management’s confidence in medium-term demand growth, underpinned by the prior quarter’s wins, remains high, with margin improvement expected.

The brokerage also noted continued strong medium-term demand, with a particular focus on higher cost-optimizing deals in the UK with faster decision-making, while the European market continues to be influential. Expectations for macroeconomic stabilization suggest an acceleration of the decision-making process. Various verticals such as BFSI, Pharma, Tech and others have witnessed encouraging quarter-on-quarter growth in the range of 1% to 4%. Most industries have demonstrated solid growth trajectories, further enhanced by a number of significant transactions in the near future.

“We believe Persistent is well positioned to support growth given its numerous long-term contracts with leading global brands. Better revenue visibility gives us confidence in the company’s continued growth. We assign a 35x P/E multiple to its 26E earnings ₹125.8/share, giving a TP of ₹4,350 per share, an increase of 24% over CMP. Therefore, we recommend a BUY rating,” Axis said.

KPI technologies: The brokerage house issued a call for shares with a target price of ₹1,750, representing a potential increase of over 16 percent.

Axis Securities monitored KPIT’s performance, noting growing demand for digital engineering, research and development (ER&D) services across industries. This shift to digital engineering creates significant opportunities for KPIT in sectors such as manufacturing, BFSI, media and technology, retail, healthcare and travel and hospitality.

In the passenger car segment, KPIT achieved solid quarter-on-quarter growth of 6.2%, and management expressed confidence in maintaining this momentum. Strategic revenues from key customers increased by 8.4% quarter-on-quarter, while customer concentration increased marginally from 85% to 86% from Q3FY24 to Q4FY24.

KPIT’s service mix remains strong, with feature development and integration services accounting for 90% of revenue, showing solid growth of 7.5% quarter over quarter. Cloud-based connected services, accounting for 26% of revenue, continued strong growth at 9% quarter-over-quarter, while architecture and middleware consulting, accounting for 29% of revenue, showed growth of 6.1% quarter-over-quarter, Papers noted Valuable Axis.

“Given the company’s strong growth potential, supported by solid dealmaking capabilities and excellent execution capabilities. We assign a P/E multiplier to earnings for 26E of 47x ₹37.1/share to get a TP of ₹1,750 per share, an increase of 16% over CMP. Therefore, we recommend BUY the company’s shares,” it was written.

Disclaimer: The views and recommendations presented above are those of individual analysts or brokerage firms, not of Mint. We advise investors to seek the opinion of certified experts before making any investment decisions.