I continue to be cautiously positive on the IT services sector as it faces near term challenges due to macroeconomic concerns in the US and Europe (key markets of IT companies). This has led to more time in decision making on the part of clients and it can lead to near term moderation in deal booking/revenue growth. The clients have become cautious especially in sectors like Retail, Hitech and Mortgages etc. regarding evolving macroeconomic situation and many of them are trying to optimize their cost structure and consequently, we expect an increase in work volume related to cost optimization projects for Indian IT companies. However, the current valuation of IT companies(down 30-40% from peak valuation) captures most of near term headwinds. The medium to long term demand environment remains strong led by accelerated adoption of technologies such as cloud computing, artificial Intelligence, machine learning, etc. by enterprises. We expect employee hiring to moderate for most IT companies in near term as they focus on training/utilization of recently hired employees. The operating margin has mostly bottomed out for the sector and we expect EBIT margin should improve sequentially during Q3FY23 and Q4FY23, led by improving employee pyramid(amid increased fresher hiring) and positive operating leverage. The costs related to travel and admin have started coming back to an extent but IT companies should be able to manage these margin headwinds through operational efficiency measures. We prefer Tier 1 IT stocks over Tier 2 IT stocks given that they are better placed to manage near term macroeconomic headwinds.
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