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IT sector less attractive after recent stocks’ rally, says Kotak Securities; check top bets

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While the IT sector has emerged as a major outperformer in the last one year, the growth may see a slowdown in the near future on account of global factors emanating from the US, uncertainty around Brexit and trade wars, according to a report. “The IT sector has performed well in the past 12 months on the back of currency tailwinds and demand acceleration. Many stocks are trading at peak cycle multiple and bake in elevated revenue growth and sustenance of profitability. This leaves little on the table to generate returns,” Kotak Institutional Equities said in a report.

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According to the firm, the estimated growth for FY2020 is seen to be broadly in line or marginally lower than FY2019. “Our checks indicate that clients are budgeting for a year of slowdown. Cost take-outs have become a key priority again and (2) tailwind from increasing digital deal sizes and accelerated deal momentum courtesy clarity on simplification of the core. Admittedly a strong exit to FY2019, bulging order book and positive commentary on demand should translate into a far better FY2020. However, the downside of a slowing market and the margin implications of the same cannot be ignored either,” the firm noted in its report.

Kotak Securities said that it prefers stocks that trade at inexpensive valuations and have potential to surprise either on revenue growth and margins. Tech Mahindra meets the criteria effectively with potential for revenue growth acceleration and available at reasonable valuations of 14X FY2020E earnings, said the firm. “Infosys has scope for revenue growth acceleration though the post-result multiple expansion and closure of valuation gap with TCS could potentially limit meaningful returns in the near term,” Kotak Institutional Equities added in its report.