Top 2 Undervalued IT Stocks in India (below Industry P/E Ratio)
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Today we will talk about a sector that has been in a lot of discussion recently. We will see what factors helped in the growth of the IT sector and also what things can contribute to the development of the IT sector in the coming times.
Today we will talk also about 2 such Indian Undervalued IT Stocks which are trading below their industry P/E due to the ongoing drawdown in the IT sector.
About Indian IT Stocks
The Indian IT industry has come a long way in the last 20 years, Here Indian IT companies have established themselves as vital players in the global IT market. INR has crossed the Rs 80 per dollar mark since September 2022. And when INR depreciates against USD, who gains the most? “Exporters” and the Indian IT services industry is our biggest exporter.
The IT Business Process Management (BPM) sector contributed 7.4% to India’s GDP in FY22. But why do exporters and IT companies benefit from a falling rupee?
Now suppose TCS signs a contract with Citibank to build a mobile application for $100,000. Since TCS is an Indian company, its revenue and financials are calculated in INR. Now if the USD/INR rate is Rs 80, then TCS will get 80 lakhs. But if USD/INR is Rs. 82, then TCS will get 82 lakhs, which means TCS gets 2.5% profit without any effort. Do you understand? And experts believe that the Indian IT industry will also continue its growth trajectory in 2023.
According to NASSCOM, the Indian IT industry is expected to reach $245bn in 2023 and $500bn in 2030. 2 factors can support the growth of the Indian IT industry in 2023.
First, the adoption of emerging technologies such as artificial intelligence, machine learning, and blockchain. Second, cyber security threats are expected to grow exponentially in 2023, requiring companies to invest in cyber security solutions to protect themselves and their customers from cyber attacks. Both these factors can support the topline of IT companies.
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Indian IT Sector Financials:
Under the financials, apart from the quarter ending March’23, the Indian IT companies’ revenue has grown continuously in the last 6-8 quarters. But the share prices of top IT companies have come down. Nifty IT has gained up to 7.66% in the last 1 year. If you are thinking that if the rupee value has decreased, and the IT companies’ revenue has increased, then why are the shares of IT companies falling?
Indian IT companies got affected negatively by the Europe and American economies as IT exports to Europe and North American companies. And due to the weak economic condition, there, clients are cutting their IT spending.
In such a situation, it is difficult for Indian IT companies to clear the payments on time by the customers or renew the contracts. The market is cautious about these factors and the same is also reflected in the share prices of IT companies. But now according to experts, the macro stress is slowly getting phased out. For example, the European economy is showing early signs of recovery.
In this situation, companies like TCS, Infosys, Tech Mahindra, and Mphasis can get large orders in the future, which will boost their growth. The sharp decline in attrition rate, lower replacement cost, and increased billing efficiency could improve the margins of IT companies.
So, with the ongoing brief on the Indian IT sector, let me now take you through 2 such Undervalued IT Stocks which are trading below industry P/E. These two Undervalued IT Stocks are:
Undervalued IT Stocks in India
We have selected only companies with a market cap between ₹30,000 crore to ₹1 lakh crore. And of course, we have handpicked those stocks whose valuations are cheaper than their peers.
Generally, the long-term P/E ratio of Indian IT companies has been in the range of 22-25, so we have taken those stocks which are trading at P/E equal to 22. In this post, we have taken the figures according to the market closing prices of 9th May 2023. So without further ado, let’s start with the first company in the list of Undervalued IT Stocks.
1. Tech Mahindra Limited
The first company incorporated in 1945 is part of the Mahindra Group, one of India’s largest and most admired companies. I know you must have already guessed that I am talking about Tech Mahindra Limited and it’s the first one in our list of Undervalued IT Stocks in India.
Tech Mahindra offers innovative and customer-centric digital experiences. The company’s highest exposure is in the telecom industry, which contributes almost 40% to its revenue. Apart from telecom, the company also caters to BFSI, manufacturing, and retail industries.
In the short term, even though macroeconomic issues like the US banking crisis, and the Russia-Ukraine war are affecting Tech Mahindra’s growth, factors like 5G, cloud, engineering, and Industry 4.0 may keep Tech Mahindra’s medium-term growth prospects healthy.
TechM’s management is confident that the revenue and margins will grow through large deals, and customer and business partnerships. TechM has comparatively low exposure to other IT companies in the BFSI segment and also has no exposure to European and US regional banks.
Now let’s talk about the 3 key growth levers for Tech Mahindra.
1. Improving Offerings for Clients in the Communications, Media, and Entertainment (CME) Segment:
UI/UX Design, Application Deployment, Adding Security Features, and Providing Full Suite IT Services making TechM one of the best companies globally. As such, they have a huge opportunity to expand clients and drive revenue growth in the CME segment.
2. Product and Platform Business Potential:
TechM’s product and platform i.e. P&P business currently has annual revenue of less than USD 500 million, but due to its reusable framework, TechM will not need much investment to scale this segment.
But what is product and platform business after all? See, apart from software, a company needs a host of services like better sales, payroll, HR, and operations to run efficiently. Earlier, companies used to do all this in-house and then it started being outsourced.
But the challenge now is not just choosing between in-house versus outsourcing, but also finding the right source for each capability. And here, Tech Mahindra’s platform helps segment companies manage technology efficiently and deliver.
For example: In the IT services industry, due to the different processes and requirements, the rollout time is usually longer, i.e. the delivery time of the product or service from the time the contract is awarded.
And ‘NetOps.Ai’ is a product from TechM that automates field services using AI to reduce the rollout time from 12-18 months to 5-7 months. Tecum is looking to grow its P&P business from $450mn/year to $1bn in the next 3 years.
3. Margin Improvement:
According to experts, TechM’s margins could improve because of better utilization, bigger deal signings, operational efficiency, and better pricing. With a report by Nomura, Tech Mahindra’s revenue is expected to grow by around 10% in the next 3 years.
Looking at the FY23 numbers, TechM’s financials seem to be on the mend. On a YoY basis, TechM’s revenue grew by 10.1% due to 3 main reasons.
Tech Mahindra has been selected as a strategic partner to develop the “Operational Support System (OSS) of the future” for Telefónica, one of the world’s largest multinational telecommunication service providers will do application development and cloudification.
TechM has entered into a multi-year partnership with a digital wellness and health technology company to improve and transform back-office medical operations.
Tech Mahindra has been selected by a South-East Asian statutory authority to build and maintain a fully integrated end-to-end platform to digitize their country’s property transactions.
2. Mphasis Limited
The second company is our list of Undervalued IT Stocks is Mphasis Limited. The company is an Indian multinational information technology services and consulting firm based in Bengaluru. It provides services like infrastructure technology, application outsourcing services, architecture guidance, application development, and integration.
After the collapse of 4 banks back-to-back in the US, some concerned banking clients of IT companies will reduce their IT spending, which may impact the revenues of Indian IT companies.
It was also said that mid-cap companies like Zore, which do business with smaller US banks, would be most affected by the cost-cutting. But the management of Mphasis has said that Mphasis has no business relationship or exposure to Silicon Valley Bank, Signature Bank, or Silvergate Capital.
The revenue from regional banks in the rest of the US contributes a low single-digit percentage to their total revenue. The company reported relatively stable results in FY23, mainly due to the volatile macro environment.
The company grew its revenue by 9.7% and operating profit by 6.7% in FY23. US revenue, which accounts for 80.8% of total revenue, declined 5.3% QoQ, while EMEA (Europe, Middle East, and Africa) and India regions revenue grew QoQ by 1.4% and 3.6%, respectively.
Mphasis is continuously investing in cloud transformation, data engineering, cyber security, and customer experience to sustain its growth. Not only this, the spending on digital transformation and risk management in the banking and insurance industry is also increasing rapidly, and this is also reflected in Emphasis’ revenue.
Interest rate volatility and the Russia-Ukraine war were cyclical headwinds in FY23. But Mphasis has maintained a strong market share and wallet share in its segment.
Now let’s talk about the 3 Major Updates related to Emphasis.
1. Slow Decision Making by Clients: Mphasis has exposure to some US regional banks in its portfolio, and poor economic conditions there have resulted in clients cutting their budgets and delaying decision-making in FY24. However, existing customers can’t drop out because of the automatic renewal options every year.
Some clients have even done renewals ahead of time due to increased workload. And this is a positive thing for companies like Mphasis.
2. No Negative Signs from Large Banks: Within the BFSI segment, Mphasis has strategically diversified into segments like retail banking, commercial banking, and credit cards.
Wherein clients like JP Morgan haven’t seen any increase in their tech budgets as they have increased their in-house spend. On the other hand, Citigroup and Wells Fargo have increased their tech budgets from 5 to 6% and 7 to 8% respectively. Hence Mphasis’ revenue pipeline and order book value look strong.
3. Margins: The company has said that it is focused on investing in potential opportunities. The management believes that the volatility in revenues is temporary, and expects growth over the next few quarters, to improve profitability. Along with this, the management has set an operating profit margin target of 15.25% to 16.25%.