Goldman Sachs downgrades big IT names from Buy to Sell 

Goldman Sachs downgrades major IT companies
Goldman Sachs downgrades major IT companies

Global Market
by 5paisa Research Team Last Updated: 2022-09-15T15:33:53+05:30

One of the top investment houses in the world, Goldman Sachs, has turned cautious on the Indian IT sector. The margin problems at IT were there for some time, but that is not the reason Goldman is worried about this sector. The concern is over the top line or the revenues getting impacted by the slowdown in demand from the US, UK and Europe. So, Goldman Sachs has downgraded TCS and Infosys from “Buy” to “Sell”, in the light of the impending macroeconomic stress. Interestingly, Wipro has been upgraded  by Goldman. 


The report specifically underlined that much of the valuation boost to Indian IT sector post the pandemic came from 3 major factors. Firstly, as manpower and operations became a major challenge, outsourcing took off in a big way. Secondly, offshoring was another trend that got accentuated in the post pandemic period and that allowed these IT companies to seriously cut down on costs. Lastly, the big boost came from digitization on the back of accelerated cloud migration. As dispersed became the norm, cloud became the go-thing.


The concerns today for Goldman are about the impact of a potential economic slowdown on technology spending. It is not just that the volume of business will go down but even pricing is likely to be squeezed further and that is likely to be a double whammy for the top line. Hence the dollar revenue growth is likely to materially slowdown. In fact, Goldman Sachs has gone ahead and cut FY24E dollar revenue growth forecast for the top 5 IT companies by 400 bps to 6% on an average. That is going to be a major valuation dampener, if it pans out.


However, Goldman is not as worried about the EBIT margin forecasts as about the revenue of Indian IT companies. Goldman feels that EBIT margins should revert to normal levels due to multiple triggers like improved employee utilisation, controls on variable pay and annual wage hikes as well as focused cost cuts. Thus the EBIT margins may still take some time get back to the old highs but any further deterioration from these levels is unlikely. However, Goldman is quite clear that the real trouble spot for IT industry will be the top line.


Let us understand the top line risks better. As US inflation gets hotter (continues to be too high at 8.3%), the fear is that inflation was getting entrenched. Hence it is now expected that an ultra-hawkish Fed might trigger a hard landing for the US economy. The negative slope of the yield curve is already indicating that possibility for some time now. One has to only look at the IT index to understand this trend. In 2022 till date, the Indian IT index is down nearly 27%, at a time when the Nifty has rallied by 4% during the same period.


Not all brokers are negative on IT. For instance, BNP Paribas has been relatively positive on the Indian IT sector. They believe that despite near-term pressure and recessionary concerns, the valuations are reasonable after losing 27% in this year. Also its strong medium-to-long-term growth potential and its ability to consistently reinvent its business model has always been a major advantage for the Indian IT sector.  Of course, there are the likes of J P Morgan, who concur with Goldman on going underweight on IT.


In the case of Goldman Sachs, the concerns have been more on the top line and less on the bottom line. However, not all brokers agree with the Goldman view. Some believe that with the cash rich positions of the IT industry, a temporary slowdown in top line is not a worry. Also, hard landing is something that is a worst case scenario for the US economy and the US has a lot of firepower to change its stance from hawkish to dovish at short notice. For now, it is fighting rampant inflation. The actual impact on IT may be more about perception.


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