Flashing Caution. (Source: BloombergQuint)

Morgan Stanley Turns Cautious On Indian IT Stocks, Rejigs Top Bets

Morgan Stanley has turned cautious on Indian information technology stocks going into the new year.

The brokerage house downgraded its rating on the sector to ‘In-Line’ from earlier ‘Attractive’ and advised investors to adopt ‘defensiveness’ and go selectively on IT services stocks.

The downgrade comes at a time when two of India’s biggest software exporters —Tata Consultancy Services Ltd. and Infosys Ltd.—indicated a pickup in deal win momentum. The flagship of the Tata Group bagged new orders worth $1 billion in the third quarter and while Infosys’ large deal signings stood at $1.5 billion during the December quarter.

Also read: In Charts: TCS Vs Infosys

The brokerage believes consensus estimates already reflect the robust IT spend/deal pipeline. The concern is profitability for two reasons:

  1. Cross currency headwinds
  2. Rising cost structures.

It says there is a possibility of the Indian rupee appreciating against the U.S. dollar, which can in turn hamper margins since most of the large Indian IT companies realise revenues in currencies other than the local unit.

The rising cost structures weighed on the quarterly earnings of both the IT bellwethers with higher manpower and sub-contractor costs.

The brokerage attributed the rising costs structures to the companies investing more in digital (domain experts, pricing aggression etc.) and local workforce as visa regulations (especially in the U.S.) become more onerous. As a result, it reduced the earnings before interest and tax margins estimates by 30-250 basis points across its coverage on Indian IT for financial year ending 2020. 

The broking firm’s top pick is Tech Mahindra Ltd. while it upgraded the rating for Infosys within its large-cap universe citing reasonable valuations in compared to their peers. Within midcaps, it turned bullish on Genpact with an ‘Overweight’ and downgraded Mindtree and Persistent Systems to ‘Underweight’.

Morgan Stanley Turns Cautious On Indian IT Stocks, Rejigs Top Bets