Brokerage firm JM Financial has initiated coverage on the Indian IT services sector with a cautious and selective stance, projecting a fourth consecutive year of subdued growth. The firm highlights rising competitive intensity and limited room for margin expansion as key challenges.
Cautious Outlook Amidst Sector Headwinds
JM Financial notes that investor conversations around Indian IT services companies are centered on several major themes. These include the growing emphasis on revenue growth, which intensifies competition and pricing pressure, and the outlook for margins in a competitive environment, further complicated by currency movements.
The brokerage also pointed to a relatively weak setup for Accenture entering FY27 due to its low exit growth rate. Additionally, the potential impact of the latest software industry results on Indian IT companies is a significant factor.
AI's Dual Impact
While JM Financial anticipates that the benefits of a recovery in software demand will become more visible as enterprises shift from AI experimentation to large-scale deployment, it also warns of potential headwinds. Productivity-driven revenue deflation could offset some of these gains in the near term, leading to a complex landscape for growth.
Growth Projections and Margin Pressures
Management commentary from major players like Tech Mahindra, Infosys, and Wipro indicates increasing competitive pressure across the industry. IT vendors are reportedly passing productivity gains from generative AI to clients through pricing, even as the benefits captured by customers remain somewhat limited. Against this backdrop, JM Financial expects the sector to prioritize revenue growth over margin expansion in the current environment.
The brokerage estimates constant-currency revenue growth at 3.5% for FY27, rising slightly to 4.1% in FY28.
Rupee Depreciation Offers Temporary Relief
Currency movements are providing a crucial, albeit temporary, support for IT services margins. JM Financial estimates that a roughly 7% depreciation in the Indian rupee during FY27 could boost operating margins by 100-120 basis points. However, this benefit might mask weaker underlying organic margin performance, and a stabilization or appreciation of the rupee could put pressure on consensus margin expectations.
Preferred Picks and Market Underperformance
Despite the cautious broader view, JM Financial has identified specific preferred picks within the sector: Sagility and Mphasis. The brokerage has also initiated two pair trades, assigning an 'Overweight' rating to Tech Mahindra Ltd against an 'Underweight' view on Wipro, and an 'Overweight' rating for Mphasis against an 'Underweight' rating for LTIMindtree.
The NSE IT index has underperformed the Nifty by approximately 12% on a calendar-year-to-date basis. Given the muted growth, intensifying competition, and limited scope for margin expansion, JM Financial maintains a cautious stance on the broader Indian IT services sector, advocating for a selective approach to stock picking.