Business
Sandip Agarwal on IT sector: Improved margins, but growth expectations need a reset
Speaking to ET Now, Sandip Agarwal from Sowilo Investment Managers pointed out that the guidance upgrade was largely a function of the recent quarter outperforming modest expectations, rather than a sharp turnaround in demand conditions.
“So yes, the Q3 performance has been slightly better than what was anticipated, and because of that, obviously, the guidance sees an upgrade. Even the upgraded guidance implies a negative to zero percent kind of growth, which is a very, very low ask. So, the numbers are definitely better,” Agarwal said.
He also highlighted the company’s execution on margins and the strength in its order book, aided by a large NHS deal. However, Agarwal stressed that structurally, the IT services industry has entered a mature phase, limiting the scope for high growth over the medium term.
“The only thing where we have a difference of opinion on the sector is that we continue to believe, based on data, that this is now a very, very mature sector. Expecting any substantial growth, even double-digit growth, for large caps is very, very tough. I do not think that is going to happen even in the next three to four years,” he said.
According to Agarwal, growth expectations need to be reset meaningfully lower. “We are more like mid-single-digit to low-single-digit growth, and for that, we believe the PEG ratios are very, very high,” he noted, adding that while strong management quality, steady cash flows and dividend appeal justify a premium, valuations still look stretched.
He estimates that large-cap IT companies may settle into a 4–5% growth trajectory, with mid-caps growing at 10–12% and small caps at 14–15%. “The PEG ratios are very, very high, except for the small caps. So that is our view, and we continue with that view,” he said.The discussion also turned to Infosys, whose ADR jumped nearly 10% overnight, sparking speculation about the stock’s opening trade in India. Agarwal was guarded in his outlook, cautioning against reading too much into ADR movements.
“It is very tough to give a call because we do not know how people are positioned. The correlation with ADRs has not played out in the past in a big way. ADRs have their own environment in which they operate—liquidity and a lot of other factors are there,” he said.
While acknowledging that the numbers were better than expected and should not be viewed negatively, Agarwal described IT as a “quasi-cash” sector. He suggested that it could increasingly be seen as a substitute for more expensive defensives.
“This is a sector which is kind of quasi-cash slowly, and maybe a good replacement for much more expensive sectors like FMCG, where the growths are similar but multiples are two to three times more expensive than this sector. So maybe some investors would like to slowly replace their FMCG proportion with IT,” he said, adding that such rotation could support IT stocks over time.
On engineering and R&D services player L&T Technology Services (LTTS), which reported weak top-line growth but a sharp improvement in margins, Agarwal said margins alone were not a decisive factor at this stage of the cycle.
“At this size of companies, what we generally look at is growth, because margins can be volatile—one time they can go up and they can also go down when scale is not there,” he said. He noted that despite slowing growth across the industry over the past two to three years, most companies have managed to broadly maintain margins.
Agarwal reiterated a relative preference for ER&D-focused companies over traditional IT services players, citing stronger long-term growth potential. “We will always prefer ER&D plays versus traditional IT services if they are available at a reasonable price,” he said, naming LTTS, KPIT and Tata Elxsi as companies likely to outgrow conventional IT services firms.
However, valuation remains the sticking point. “The only challenge is that this is already discounted by investors. They are way ahead of time and have assigned a much, much higher premium to them. So it becomes very difficult for us to justify them on the valuation front,” Agarwal said.
Summing up his stance, Agarwal struck a distinctly cautious note. “I believe the sector is very, very expensive. Unless someone wants to replace something which is even more expensive with this, there is no real investment rationale in the sector currently,” he said.
