TCS, Infosys and HCL Tech can do better in a shallow recession than a slowdown

• Unlike other sectors, the IT sector is well placed in a volatile and recession feared market as its demand environment is strong despite high inflation.
• Companies are still spending fortunes on digital transformation of their businesses.
• Even if recession takes place, the IT spending growth will remain above normalized levels.

The IT stocks have been melting for weeks now in fear of a possible recession that can affect its largest market – the US. While investors and analysts alike are nervous about it, a recent brokerage report has underplayed its effect on the IT sector as a whole and Indian service providers in particular.

As companies are spending a fortune on digitization, the IT sector is well placed in a volatile and recession-feared market as its demand is strong despite high inflation, says a report by Kotak Institutional Equities.

And, the tech spending cycle wave is in favour of IT companies like TCS, Infosys, Wipro, HCL Tech and more.

“The current recession, if it does materialize, will impact the supply chain and retail segments more than financial services. Assuming the recession is shallow and swift, the financial services segment could hold up better than others,” said the report.

Financial services are the largest IT spenders and biggest clients of Indian IT majors.

Recession is typically defined as a significant decline in economic activity that is spread across the economy and lasts more than a few months. Currently, prices of gas and food are at record high in the US resulting in 40 year high inflation.

Several reports indicate the US is likely to fall into recession. Morgan Stanley CEO James Gorman said to Reuters there is a 50% chance the US economy will enter a recession.

Shallow recession or a deep recession
If a recession occurs, clients have an option to either elongate the digital transformation journey or stop it midway. It is very unlikely for a running company to stop its growth journey.

“Irrespective, the important point is that we expect IT spending growth to remain above normalized levels as clients progress towards the transformation journey, even as there may be an odd year or two of below-trend level growth,” says the report.

In a slowdown situation however, companies see no huge investments coming in or opportunities that could boost margins while a shallow and swift recession leads to clearer priorities by clients to advance their businesses.

So even if the recession comes, there will be a downtrend in the IT services sector but the effect will be very moderate.

“Profit warning from clients of IT companies and increasing external risks makes the assumption of 6-8% global IT spending growth, unreasonable. We moderate our stance and bake in normalized global IT spending growth of 3-4% for 2023E and 7% for 2022E,” added the report.

On the bright side, the recession is expected to cool off the high attrition rate faced by the IT industry for a long time now, said the report.

Infosys and TCS standout among other players in the recession-fearing market. Mphasis and HCL Technologies can also survive the bad phase. However, Wipro’s recent acquisitions make it more vulnerable, as per Kotak.

Due to the heavy selling in IT stocks, analysts expect the stocks to bottom out at higher multiples and then move up from there.


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