 |
|
The Indian IT sector is facing renewed headwinds due to concerns over a potential US-led recession, sparked by President Trump's imposition of broad “reciprocal tariffs” impacting over 180 countries. The United States remains a pivotal market for Indian IT services, and any economic downturn there is anticipated to substantially impede the sector's growth trajectory. Kotak Institutional Equities has issued a stark warning, forecasting a possible downside of up to 38 percent for Indian IT stocks should the global economy slide into a tariff-induced recession. This projection underscores the vulnerability of the sector to geopolitical and macroeconomic factors. The Nifty IT index experienced a modest recovery, gaining 1.7 percent, after a sharp three-day losing streak, highlighting the volatility and investor uncertainty surrounding the sector. The recent losses demonstrate the immediate impact of tariff-related anxieties on investor sentiment. Despite the day’s gains, the overall trend remains negative. Over the past year, the index has declined more than 7 percent, indicating a sustained period of underperformance. The weakness has persisted into the current financial year, with April alone witnessing a 10 percent drop so far. This marks the fourth consecutive month of losses for the sectoral index, following declines in March, February, and January, signifying a prolonged period of bearish sentiment. Kotak Institutional Equities estimates that IT stocks under its coverage could correct by 19–38 percent from current levels in a worst-case scenario, a potentially significant correction. The brokerage said the overall downside for the sector could be as high as 38 percent in a recessionary environment triggered by the new US tariffs, emphasizing the severity of the potential impact. The report suggests that the Indian IT industry is unlikely to replicate the robust recovery it experienced during previous downturns, such as the 2009 and 2020 recessions. The circumstances are fundamentally different, with diminished opportunities for a strong rebound. “Unlike in 2009, when outsourcing and legacy vendor replacement drove growth, or in 2020, when enterprises rushed to digitize and migrate to cloud, there is limited visibility of any similar untapped opportunity emerging post a recession this time,” the note said. This indicates a lack of clear drivers for a swift recovery, making the current situation more challenging than past crises.
Kotak Institutional Equities anticipates a slow and uneven recovery in revenue following a recession, further dampening prospects for the sector. In its base-case scenario, which assumes no recession but a slowdown in growth, Kotak forecasts revenue growth of just 3.7 to 4.5 percent in FY27E for top-tier companies such as Tata Consultancy Services (TCS), Infosys, and HCL Tech. This modest growth expectation reflects the cautious outlook for the sector. Growth is expected to be driven by cost optimization deals and a minor recovery in discretionary spending, but these gains are likely to be offset by pricing pressure from AI-led automation and persistent cost controls. The increasing adoption of AI and the focus on cost reduction are expected to negatively impact revenue growth. Margins are also expected to face downward pressure. Kotak projects a contraction of 90 to 140 basis points in EBIT margins during FY26–27 for large-cap IT firms, indicating a squeeze on profitability. This margin contraction is attributed to weak pricing, fading rupee depreciation support, and the exhaustion of traditional margin levers. Tech Mahindra is expected to experience a steeper margin fall compared to its peers, highlighting its specific vulnerabilities. Among large IT names, Kotak views TCS as having the least downside risk, followed by Infosys, HCL Tech, and Coforge, suggesting relative resilience for these companies. In contrast, mid-tier IT companies like Persistent Systems and Mphasis are seen as the most vulnerable to corrections, both in terms of earnings and valuation. These companies may face greater challenges in navigating the anticipated downturn. While the firm believes companies that can capture market share through vendor consolidation or large renewals may bottom out at better valuations, the overall expectation is still a steep 19–24 percent downside for large-caps and 21–35 percent for mid-tier IT firms over the next 12 months. This suggests that even well-positioned companies are likely to experience significant corrections.
Kotak Institutional Equities has also revised its price-to-earnings (PE) multiple assumptions, expecting them to bottom in the range of 15–18x for Tier-1 companies and slightly higher for some mid-tier names. This adjustment reflects the expected decline in investor confidence and valuation multiples. This translates to a 22–38 percent cut in base-case target prices and an 18–35 percent fall from current stock levels. These revised targets underscore the significant potential downside for the sector. In summary, the Trump administration’s aggressive tariff policy has introduced a fresh layer of uncertainty for India’s IT sector, which is already grappling with a global growth slowdown. The combination of tariffs and slowing growth creates a challenging environment. While industry bellwethers like TCS and Infosys may fare relatively better, Kotak Institutional Equities believes the broader IT space could face meaningful valuation corrections if recessionary conditions take hold. Even the stronger players in the sector are not immune to the potential downturn. Investors are advised to tread with caution, as pricing pressure, margin squeeze, and limited post-recession tailwinds may weigh on the sector's near-term prospects. Prudent investment strategies are recommended in light of the prevailing uncertainties. The potential for a tariff-induced recession poses a significant threat to the Indian IT sector, potentially leading to substantial valuation corrections and reduced growth. The sector faces challenges from both external forces, such as tariffs and global economic slowdowns, and internal pressures, such as pricing competition and margin erosion. Investors should carefully assess the risks and potential rewards before making investment decisions in this uncertain environment. The analysis provided by Kotak Institutional Equities offers valuable insights into the potential impact of these factors on the Indian IT sector, aiding investors in making informed choices.
Source: IT stocks may face up to 38% downside amid Trump tariff shock, says Kotak Institutional Equities