- Jefferies turns cautious on India IT sector amid AI-driven business model shifts
- IT stocks have risen 16% YTD, but risk-reward remains unfavourable with earnings cuts
- Prefers mid-sized IT firms like Coforge, Sagility, and IKS for faster projected growth
Jefferies has turned cautious on India's IT services sector, warning that artificial intelligence could structurally alter business models and compress valuations, even as stocks have rebounded this year.
Despite a roughly 16% rise in IT stocks year-to-date, Jefferies believes risk-reward remains unfavourable. The brokerage cut earnings per share estimates by 1-4% and reduced price targets by as much as 33%. It downgraded Infosys, HCLTech and Mphasis to 'Hold', and moved TCS, LTIMindtree and Hexaware to 'Underperform'. Wipro remains 'Underperform'. Coforge, Sagility, and IKS Health are its preferred picks.
In a note titled 'P(AI)n Not Over Yet; Stay Selective,' the brokerage said AI is likely to shift the revenue mix toward consulting and implementation work while shrinking traditional managed services. Such a transition may increase revenue cyclicality and demand significant changes in talent and operating models, adding execution risks for companies.
Earnings Upgrades Offset by AI Concerns
Jefferies noted that while third-quarter results led to earnings upgrades for nearly all IT firms, investor focus has shifted toward the medium- to long-term implications of AI. The Nifty IT index has fallen about 14% and underperformed the broader Nifty 50, reflecting concerns that technology-led efficiency gains could pressure pricing in core services.
The brokerage expects application managed services - which account for roughly 22-45% of revenues for large IT firms - to face deflation as AI tools improve. A higher share of advisory and implementation work may support growth but could also require changes in delivery strategy and cost structures.
Valuations Vulnerable to Derating
Jefferies estimates that current stock prices imply revenue compound annual growth of 6-14% for large IT firms and 9-17% for mid-sized players over FY26-36. These assumptions are below historical growth rates for several companies, yet the brokerage sees scope for further valuation compression.
In a base case, price-to-earnings multiples for large IT firms could see limited upside, while mid-sized names may offer stronger rerating potential. In a downside scenario, stocks could face additional derating of 30-65%, particularly if revenue growth slows materially.
Jefferies expects sector earnings CAGR of around 6% over FY26-28, with Coforge, Sagility and IKS projected to grow faster at 19-25%. It prefers mid-sized IT firms, citing greater agility in adapting to AI-driven shifts.
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