“AI could structurally shift the IT business mix towards consulting/implementation while shrinking managed services. This will not only increase cyclicality, but also require a change in talent/operating model, thus adding risks. Despite a 16% drop YTD, stocks still offer more downside than upside,” said Jefferies analysts including Akshat Agarwal.
The brokerage notes that application-driven services, which account for 22-45% of the revenue of large Indian IT companies, face sharp revenue deflation “with the extent and timing of this deflation… AI tools likely to get better”.
Its reverse-DCF analysis suggests that at current prices, the market is factoring in a rupee revenue CAGR of 4-7%-1 percent with a lower growth assumption of “6-14% for large IT companies and 9-17% CAGR for mid-sized IT companies during FY26-36”, which is already lower than FY1-26 percent. way for most.
The House lays out three long-term scenarios to frame valuation risk. In the best case, AI has no impact on long-term growth and income growth remains in line with the last decade.
In the worst-case scenario, the Jefferies model projects a revenue CAGR of 3% over FY26-31 (15% cumulative deflation) and then no growth after FY31, implying that IT stocks “could decline by a further 30-65%” from current PE multiples, with “Wipro the lowest and potential for coforge.”
Even in the mid-case where growth is as low as 3% through FY36 and terminal growth is less than 1 percent, he sees scope for multiple compression of 10-35% for large caps and up to 15% for midcaps.
These structural concerns have triggered a broad reset in Jefferies’ ratings and targets. Infosys and HCLTech have been cut from “buy” to “hold”, with target prices of Rs. 1,290 (from Rs. 1,880) and Rs. 1,390 (from Rs. 1,885), as target PE multiples have been narrowed to 23x and 16x for Inx2 to 16. HCLTech.
TCS, LTIMindtree and Hexaware have been downgraded to “Underperform” (U-PF) from “Hold”, TCS is now at Rs. 2,350 (from Rs. 3,485), LTIMindtree Rs. 4,300 (from Rs. 6,175) and the Hexaware at Rs. 460 (Rs. 460) is at. Mphasis has been cut to “hold” from “buy” and has a target of Rs. 3,410 to Rs. 2,450, while Wipro Rs. 220 against Rs. “Underperform” remains with a lower target of 180.
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Jefferies says it has cut earnings estimates by 1-4% and expects a 6% earnings CAGR in FY26-28 for the large-cap IT basket, its EPS estimates 3-14% below consensus. It flags three key derating triggers: “Risks to consensus estimates, sharp 32% PE premium for Accenture despite similar growth and similar PE vs. Nifty IT despite lower revenue growth of 50%. IT, he points out, trades at around 20x one-year forward PE, below its 10-year average of 21.4x but still at a valuation premium to Nifty which “Lower Earnings vs. Nifty Needs Further Reduction in Growth Factor”.
While taking a defensive stance on big names, the brokerage remains selectively constructive on fast-growing mid-sized IT and BPO players.
“We prefer mid-sized IT companies as they should grow faster due to their better ability to move quickly to new opportunities. However, he cautions that there are risks in the near-term set-up for the sector as IT stocks offer more downside than upside at current prices.
(disclaimer: Recommendations, suggestions, opinions and views given by experts are their own. (These do not represent the views of The Economic Times)
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