As we entered the new year, how is the IT services industry expected to perform in CY25? Per JM Financial, CY25-start has little in common with CY24. Last year this time, the book of business was transitioning from (eroding) discretionary book to efficiency-led work. Per the analysis report by the brokerage firm, leakages have reduced since then and mega deals’ contribution is now in the base. In fact, it added, players now need short duration discretionary deals to pick-up to make up for declining TCV.
Further, while US Fed’s dovish turn in December 2024 raised hopes of faster rate cuts which triggered re-rating in IT Services stocks then, December 2024 saw a totally opposite scenario – hawkish tone, elongated rate-cut projections and a sell-off. In other words, a better demand environment is balanced by somewhat unfavourable comp and higher expectations. This different set-up means the construct of stock return could be different too.
S&P 500 earnings growth is likely to improve to 15 per cent in CY25 (Source: Factset). Unlike CY24, where bulk of earnings growth is being led by Magnificent 7, JM Financial said, it will also be broad based. That suggests cost pressures might ease across enterprises, paving the way for discretionary spend off-take. “That said, a still gummed up global supply-chain, uncertainty around Trump’s trade policies and a sudden shift in Fed’s tonality mean long gestation (back-ended ROIs) projects may get pushed out. Our checks also suggest that IT budgets are unlikely to improve materially,” the report stated.
According to the brokerage firm, one reason for optimism on IT Services demand post Trump’s election is potentially lower corporate taxes (18 per cent from 21 per cent for domestic production). However, it said that the impact, though positive, would be marginal. “Effective tax rate – calculated simply as (PBT-PAT)/PBT – for S&P 500 has fallen by 0-11ppt across sectors over 2016-23. Two verticals where ETR is still above 20 per cent – Consumer Staples and Energy – growth expectations are the least. Business outlook, and not fiscal support, will determine IT Services demand, in our view,” JM Financial said.
Communication Services (CS) has been one of the worst hit verticals for IT Services providers recently. That, per JM Financial, could change in CY25. CS companies in S&P 500 saw the most earning surprises in Q3. As a result, the CS sector witnessed the highest earnings upgrades over the past six months within S&P 500. “Our excess IT spend analysis also suggests post-COVID excess spend in Telecom has likely flushed out now, resetting the base. These typically precede inflection in IT Services spend. If they do, Tech Mahindra could benefit more,” it said.
Among the top 5 large cap IT services companies which gave 7-32 per cent return in CY24, every other stock barring TCS saw PER expansion. JM Financial said that while TCS’ premium to large-cap peers is now at decadal low, investors are positioned for demand recovery. “BSNL ramp-down and recent disappointment in core growth mean TCS’ growth could lag peers in FY26. CMP is already discounting these risks, in our view. Sustained improvement in US BFSI and delay in broad-based discretionary spending could play in TCS’ favour,” the report stated.
Can TCS bounce back? JM Financial said, “Improvement in US BFSI and a still cost constraint IT budget environment could lower TCS’ growth differential with peers in FY26, in our view. This could lead TCS’ PER premium with peers to mean revert. We however maintain a HOLD rating for as we find Street’s current FY26E USD growth still elevated. Note, we are building similar growth in FY26 as FY25 (4.4 per cent) for TCS vs acceleration for others. We will turn constructive once we see more realistic cons. Estimate.”
