The first quarter earnings season has triggered sharp stock corrections for most of the mid-tier Indian IT companies and has turned out to be a reality check for them. HSBC has flagged margin volatility, capital intensity, and weak cash flow conversion as growing areas of concern.
Even so, according to a report by HSBC, mid-tier IT offers higher growth potential compared to top-tier companies, on the back of factors like size advantage, relationship with upstream software vendors, margin arbitrage, and aggressive management incentives.
Q1 shake-up
HSBC said that most of the mid-tier IT firms saw sharp corrections post their Q1FY26 results with most of them missing investor expectations, with some idiosyncratic take-away.
Here are the key takeaways:
– MphasiS reported a sharp decline in its top logistic client, but despite that, also reported strong growth and extremely strong deal wins.
– Persistent’s Q1 growth disappointed on expected weakness in its healthcare business, though it remained optimistic of a pick-up going forward.
– Hexaware managed to sustain strong core margins, though its topline missed expectations and it toned down its FY26 growth outlook.
– Coforge expressed confidence in its margin expansion going forward, though capex may remain high this year with margin one-offs and weak free cash flow (FCF). The company is investing in data-centres for its clients.
– Cyient maintained its weak operational trend.
IT sector Q1 results: Key areas of concern
1. Capital intensity on the rise
According to HSBC, the capital intensity trend is becoming more pronounced with this quarter. Coforge has been at the epicentre of this debate as the company’s FCF to revenue conversion has been at an average of 5 per cent in recent quarters. This was driven by a rise in contract assets and heavy capex—largely due to investments in building client data centres. Persistent Systems (PSYS) has seen a similar increase in contract assets leading to weaker cash conversion. Even MphasiS, during the first quarter, reported similar trends, suggesting most companies are leveraging their balance sheets to offer better terms for fixed-price contracts.
2. Weak cash flow conversion
The proliferation of contract assets—essentially work done but not yet billed—has become a drag on cash conversion across mid-tier players. The HSBC report maintained that the transition of these contract assets to unbilled revenues and eventually to receivables will be a key trend to track in the coming quarters. Furthermore, the pace and certainty of this transition will depend on strict Service-Level Agreement (SLA) terms and client payment behaviour.
3. One-offs and margin uncertainty
Margins are traditionally a strength for mid-tier IT. According to HSBC, these are now under pressure from one-off expenses, capex outlays, and transition costs. For example, even as Coforge expressed confidence in margin expansion over the rest of FY26, HSBC still warned that recurring one-offs and high capital expenditure may continue to weigh on profitability in the near term.
To conclude…
While the sector is reeling under concerns like rising capital requirements, slower cash flows, and shifting client dynamics, HSBC underscored the need for close monitoring of balance sheet health and execution discipline. Mid-tier IT firms still have strong growth potential due to their size and specialized services, but rising margin uncertainty could temper investor enthusiasm going forward.