Kotak Downgrades HCL Tech and Persistent Systems; Infosys Retains Top Pick Status, According to Brokerage Firm

December Surge: HCL Tech and Persistent Systems Stocks Up Nearly 11%, Infosys Gains Over 6% in Share Prices

December Rally: Nifty IT and BSE IT Indices Surge Approximately 8%, Reports Utpal Sarkar

Kotak Institutional Equities, a brokerage firm, has downgraded two IT players, namely HCL Technologies and Persistent Systems. This decision is based on the recent significant rally in the stock prices of these companies.

According to the brokerage, the strong rally observed in these stocks has led to a situation where there is limited potential for further upside in select stocks within the IT sector.

Essentially, the brokerage firm believes that the current surge in stock prices has reached a point where the future growth or increase in value may be constrained, leading to the decision to downgrade these particular IT stocks.

HCL Tech Share Price:

• HCL Tech’s share price has experienced a substantial gain of nearly 11 percent in December.

Persistent Systems Share Price:

• Persistent Systems’ share price has also seen a notable increase, gaining over 9 percent in December.

Nifty IT and BSE IT Indices:

• The Nifty IT and BSE IT indices, which represent the IT sector, have witnessed a collective jump of about 8 percent in December.

Infosys:

• Infosys retains its position as the top pick among the IT services companies covered by the brokerage firm. This suggests that, according to the firm’s analysis, Infosys is expected to perform well relative to its peers.

HCL Tech:

• HCL Tech is identified as the next pick after Infosys. While it may not be the top choice, it is still considered favorably by the brokerage firm.

Cyient:

• Cyient is mentioned as the preferred pick among mid-tier IT stocks. This indicates that, within the mid-tier segment, Cyient is seen as having favorable prospects.

In December, Infosys Share Price Registers a Gain of Over 6 Percent, Continuing Positive Trend.

Kotak Highlights IT Stock Rally: 7-18% Surge Over the Past Month, Notably During the Last Week

Kotak suggests that the recent upward movement in stock prices following the Federal Reserve’s (Fed) move was considered a bit overly optimistic by the brokerage firm.

The Federal Reserve’s actions often have a significant impact on financial markets, and in this case, it led to a rally in stock prices.

However, Kotak expresses caution, stating that they believe the resulting rally was too optimistic given the current circumstances.

The firm points out that their existing estimates for revenue growth and earnings per share (EPS) already account for positive factors expected in fiscal year 2025.

These factors include anticipating a soft landing in the United States and a reduction in demand headwinds.

Fair Value Adjustments:

• Kotak increased fair values by 9-20 percent due to a rollover and an increase in multiples. This adjustment takes into account a reduction in macroeconomic uncertainty.

Limiting Upside in Select Stocks:

• The brokerage firm notes that the strong rally in stock prices limits further upside in certain stocks, suggesting that the recent market performance has already factored in positive expectations.

Rating Changes:

• Kotak downgraded HCL Tech’s rating from ‘buy’ to ‘add’ after a 13 percent increase in its stock price over the past month.
• Persistent’s rating was downgraded to ‘reduce’ from ‘add,’ as its stock trades at 33 times FY2026E EPS and is considered expensive following a 22 percent rally in the past three months.

Kotak emphasized that IT players experienced a notable decline in demand in FY24. This decline is attributed to several factors, including:

Reluctance to Commit to New Programs:

• High economic uncertainty led to companies being hesitant to commit to new programs or initiatives.

Reprioritization of Spending:

• There was a shift in spending priorities away from Covid-era initiatives toward efforts focused on efficiencies and optimization.

Excess In-House Hiring:

• Companies may have engaged in excess hiring internally, reducing the need for external IT services.

Longer Sales and Ramp-Up Cycle in Mega Deals:

• Mega deals, which involve significant contracts, experienced longer sales and ramp-up cycles, possibly due to increased scrutiny and evaluation.

Impact on Large Companies:

• Large IT companies experienced muted revenue growth, with figures ranging from 2-5 percent. This suggests a relatively slower expansion in revenue for these companies.

Impact on Mid-Tier Companies:

• Mid-tier IT companies faced a broader range of revenue growth, with figures spanning 6-14 percent. Despite the challenges, some mid-tier companies showed more resilience and achieved higher growth compared to their larger counterparts.

Revenue Decline for Specific Companies:

• Kotak highlighted that revenue declined for specific companies, including Wipro, Tech Mahindra, and Mphasis. This indicates a contraction in the overall revenue for these particular companies during the specified period.

Kotak Believes IT Sector Headwinds Bottomed Out, Anticipates Incremental Demand and Revenue Growth in FY25. Base Case Factors in Positive Trends and a Soft Landing for the US Economy.

Kotak: Current PE Multiples Lower but Nearing FY22 Peaks; Forward Growth Estimates Considerably Lower. FY26E Revenue Growth Projections 1-4% Below FY24E Estimates from Two Years Ago.

Kotak’s Estimates Factor in Strong June and September Quarters, Assuming a Soft Landing, Momentum in Large Deals, and Substantial Recovery in Discretionary Spending, Particularly in Financial Services and Hi-Tech Verticals.

Kotak Acknowledges Downside Risks to June Quarter Estimates, Anticipates Continued Enterprise Focus on Cost Reductions in 1HCY24. While a Growth Beat in 2HFY25 Is Possible with a Discretionary Spending Pick-Up, It May Not Significantly Improve FY2025E Estimates for IT Companies, According to Kotak.