One research firm says shares of Infosys, HCL Tech, and TCS may see another surge — here's why

• Indian IT services companies Infosys and HCL Tech may see their stocks increase by more than 50% in the coming year, according to Edelweiss.
• The current ‘tech upcycle’ could also put mid-cap stocks like MindTree and L&T Infotech on the road to becoming large caps by 2035.
• The surge of growth is pegged on the faster-than-expected recovery of the BFSI vertical, the prioritisation of spending on cloud services and the reduction of costs due to most employees working from home.
  

The COVID-19 pandemic may have wreaked havoc on many industries but the IT sector exhibited extraordinary perseverance. Edelweiss estimates that despite the rally seen over the last three months, the best is yet to come.

And, Indian IT stocks like Infosys, HCL Tech and TCS are most likely to reap the benefits. “Among mid-caps, we believe Mindtree and L&T Infotech might well be the large caps of 2035 (perhaps much like Infosys and TCS, respectively),” said the analysts’ December report on the IT sector.

Source: Edelweiss Research

This is because ‘clients are more determined to spend than ever before,’ according to Edelweiss. This is further bolstered by the fact that the IT companies themselves are gaining on margins with employees working from home.

Most companies will have a larger than usual budget for tech upgrades
Companies don’t normally carry over their budget allocation for IT into the next year. But this time around, they’re making an exception.

Majority of IT departments are likely to carry forward any of the unused technology budgets from 2020 into 2021, according to Edelweiss. That means next year, most clients of IT services companies will have a significant amount to spend in addition to traditional allocation for technology upgrades.

Source: Respective company reports

“[This implies] FY22 revenue growth for Indian technology companies can be comfortably in the 12–14% range or even more,” said the report.

The best phase of the ‘tech upcycle’
The surge in spending on technology upgrades has been dubbed the ‘tech upcycle’. It’s a result of the increase in online activity during the coronavirus pandemic.

Back in June, the upcycle was just kicking off and the most expansive phase — when the money actually starts rolling — is yet to begin. This is called the ‘squeeze up’ phase of the cycle.

Why will some companies gain more than others?
According to Edelweiss, all IT companies have something to gain from the increased spending on digital that will flow in. But, some will gain more than others depending on where their focus lies within the digital space.

For instance, spending on cloud technology is more important than investing in non-cloud digital services. “Cloud has clearly taken precedence in spends as clients now increasingly and strongly-than-ever believe that they need an agile IT infrastructure to manage variable data loads,” notes the report.

With companies like HCL Tech, Infosys and TCS being the strongest contenders for cloud technology right now, they have the most to gain.

Another positive for these companies is that the BFSI segment, in particular, is witnessing decade-high budgetary allocations to upgrade its technology.


IT sector gains aren’t without its risks
The IT sector may be on the precipice of massive growth but the risks have never been higher. A serious data breach — keeping in mind that the number of cyberattacks on companies during the last six months has been increasing — could have a serious impact on client trust and customer confidence.

The depreciation of the dollar versus the rupee could also moderately affect growth and the resulting earnings estimates of IT companies, according to Edelweiss.

And, while it is true that technology spends are stepping up, the North American market is an exception to that rule. Since most clients within the US are already digitally savvy, their budgets for IT may be slashed. Indian IT companies may bear the brunt since, for most, the majority of their revenue comes from customers in the US.

Lastly, while the BFSI sector is racing to catch up, it also means there’s a higher risk of companies within that vertical declaring bankruptcy. If a large enough BFSI client was to go bust, it wouldn’t impact the whole industry, but the IT services company providing services would be in for a rough ride.

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