The consensus earnings per share (EPS) estimates for top five IT firms including Tata Consultancy Services Ltd (TCS), Infosys Ltd, HCL Technologies Ltd (HCL Tech), Wipro Ltd and Tech Mahindra Ltd (TechM) are down 4-27 per cent over the past 12-months.
Despite this, JM Financial said the prevailing 12-month forward earnings growth estimates are at 11-55 per cent, higher than past inflection points, thanks to high expectations at the beginning of current downgrade cycle and hopes of recovery already built in.
In addition, current earnings growth is tracking well below last year’s forward estimates, it said adding that the trend looks similar to 2013-17 period for TCS and Wipro when sustained negative earnings surprises led to an elongated period of low stock return.
"We therefore believe that while the worst of earnings downgrades might be behind, there are still not enough evidence to suggest that actual earnings could meaningfully exceed current estimates," it said.
Infosys
JM Financial said Infosys' consensus 12-month forward earnings growth estimate is currently at 11 per cent. This, it said, is based on Street’s expectations of large-deal led growth acceleration. JM Financial estimates that despite healthy large deal wins, Infosys ACV growth in FY24 is likely to be in low single digit. "We therefore believe that Infosys' initial FY25 guidance could surprise negatively.
TCS
In the case of TCS, JM Financial said earnings growth estimate for the largest IT player too stands at 11 per cent. While it does not see downside to the estimate, a positive surprise also looks unlikely, the brokerage said.
Wipro
In the case of Wipro, the actual earnings growth trajectory appears to have turned. That, JM Financial said, explains Wipro's outperformance of 31 per cent return over past one year against 5 per cent rise in shares of Infosys and 15 per cent jump in stocks of TCS.
HCL Tech, TechM
JM Financial said HCL Tech's negative earning surprises have been the least. For TechM, earnings growth estimates have risen sharply while actual growth continues to trend down, widening the gap between the two.
"While current depressed margins for TechM mean the earnings should trend up, an already high ask rate makes positive surprises difficult. Overall, barring Wipro and HCL Tech, we see limited scope of positive earnings surprises among top-5 players," it said. Infosys and Tech Mahindra seems most at risk of negative surprises, it said.
More legs to stock rally unlikely
The brokerage said there is neither enough pessimism in the current estimates nor is there sufficient optimism in the environment for actual earnings to exceed these elevated expectations. These make the current situation an unlikely inflection point.
"Steep earnings cuts (due to weaker guidance) or sharp rebound in discretionary spend could possibly change that. In absence of those, current rally is unlikely to have more legs, in our view," it said.
JM Financial said the Q3 earnings raised hopes of earnings inflecting, driving up IT stocks. Its analysis of past 15 years’ earnings trends for top-5 players suggest that the best time to invest in IT Services stocks have been in and around these inflection points
(Exhibit 4).
"However, not every turn in earnings trajectory results in strong stock return. It is
therefore important to understand what characterises an inflection point. With the benefit of hindsight, we observe that stock returns are the highest when a trough forward earnings growth estimate (peak pessimism) is succeeded by strong actual earnings growth (positive surprise). In contrast, current 12-M forward earnings growth estimates for top-5 (11-55 per cent) are still high compared to historical troughs. Besides, current actual earnings growth is tracking below last years’ forward earnings (negative surprise)," it said.
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