3 takeaways from IT sector Q4 results. Infosys, HCL Tech best stock picks, says Kotak

In its quarterly review, Kotak Institutional Equities said it has derived three conclusions from the recent earnings season for IT companies. The first is that the slowdown in growth is broad-based across companies and is led by banking and financial services (BFS), communications and North America. The second is that the guidance of IT companies is based on quick recovery, which it feels is an aggressive assumption.

The third is the fact that IT companies are willing to carry the extra cost of people, fact in hopes of quick recovery, making them vulnerable to a short-term margin correction in case demand does not recover.

Kotak said the June quarter will be weak, as the full impact of the banking crisis and slowdown impacts financial performance. But it felt that valuations for select companies have corrected, making them attractive. Infosys and HCL Technologies are Kotak's top picks.

After a 7-20 per cent correction in stock prices, valuations are reasonable for select companies, it said while noting that the valuations assume 3-4 per cent growth acceleration and some level of margin expansion in FY2025E.

"A slowdown was expected. The only difference was that the slowdown was far sharper. All large companies missed revenue estimates or were at the lower end of the expectation band (HCLT was an exception, but largely down to surprise in the products business). Mid-tier companies had a mixed showing, with some exceeding expectations and others missing it," it said.

Kotak said the slowdown was led by the US markets and certain verticals such as financial services, hi-tech and communications.

This decline, it said, was due to a pause in discretionary programs and even cancellations.

"The June quarter will be weak, as the full impact of the banking crisis and slowdown impacts financial performance. The confidence of companies about a growth revival is based on a strong deal pipeline and hope of some macro revival in the second half. The hope for a quick macro revival will be tested," Kotak said.

The domestic brokerage said the hurdle rate to achieve the top-end of the guidance is a bit unrealistic, unless backed by mega deals. It sees growth rates at the mid-point to the lower-end of the guidance range across companies.

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