Nuvama Bullish on Tier-2 IT Stocks, LTI Mindtree Among Top Picks

Nuvama, a brokerage firm, expresses optimism about tier-2 IT stocks, highlighting LTIMindtree among its top picks. The firm notes that these companies have outperformed larger counterparts in terms of growth and margins over the past five years, undergoing a significant transformation in their business profiles.

While mid-cap and small-cap stocks have outperformed indexes in recent months, Nifty IT has marginally underperformed the broader index. Nuvama attributes the success of mid-cap IT to their radical transformation, reaching a critical size that allows them to bid for large deals. The brokerage remains positive on select quality tier-2 companies and the IT sector as a whole.

Nuvama’s investment thesis for these tier-2 IT service providers is built on five pillars:

1. Size Begets Growth: The CLAMP companies have evolved into elite groups of USD1 billion and above, with 20%+ CAGR in revenue over FY21–23, enabling them to participate in a broader range of deals.
2. Business Profile Diversification: The business profiles of these companies have transformed over the last three years, resembling their larger peers and reducing dependence on one client or vertical.
3. Leadership Change Impact: CEOs from tier-1 companies taking leadership roles in tier-2 companies have positively influenced growth trajectories, business diversification, and overall optimization.
4. Permanent Margin Reset: The margin trajectory for the IT sector has experienced fluctuations over the past three years, with a permanent reset due to factors such as higher offshoring, lower travel and facility costs, and increased attrition.
5. Valuations Justified: Nuvama believes the market ascribes a premium to tier-2 IT companies due to their sustained growth outperformance and business transformation, comparing them to the trajectory of larger peers like Infosys and Cognizant in the past.

The brokerage retains a ‘BUY’ recommendation on LTIMindtree, considering it a top pick in the sector, along with Coforge and Persistent. However, it initiates coverage on Mphasis with a ‘REDUCE’ rating due to relatively expensive valuations.”