With demand uncertainties in the IT services industry from H2CY24 having trickled into CY2025 budgets, Kotak Institutional Equities (KIE) said, the weakness will continue in FY2026. The demand pipeline has built up well at most ERD service providers with exposure to the automotive vertical. However, it added, deferral of decision-making by German OEMs has impacted conversion. Demand outlook at other manufacturing-focused industries is also yet to improve. “We bake in a moderate demand outlook, leading to cuts to earnings estimates across companies. We retain our cautious view owing to slowing macro and weak demand outlook despite a ~14-40 per cent decline in stock prices over the past three months,” KIE report said.
Healthy pipeline but conversion stuck in a limbo
Per the analysis report, automobile OEMs are realigning their investments to meet evolving demand patterns. “While new platform development-related spends remain relatively resilient, OEMs are at a crossroads to either double down on electrification initiatives or channel investments toward alternate powertrains (hybrid/ICE). Auto OEMs realize the need to invest in new technologies to ensure business relevance,” the Kotak report stated.
The pipeline, the report said, has built up to record levels across most Indian and European players, as more RFQs (Request for Quotation) are floated by clients. The uncertainty around the medium-term strategy has impacted decision-making and as a consequence, conversion into the order book.
Kotak said that impact has been more severe for German OEMs and has percolated down to the spending outlook by these clients. “We believe spending would remain weak in H1CY25, but the recovery is likely to be gradual, resulting in a weak growth outlook for the year,” it said.
Pricing pressure might stem from increased competitive intensity for large deals
Auto OEM R&D spending growth in CY2025 will be modest, with a focus on efficiency and shifting investments to low-cost countries from nearshore locations. Kotak Equities said that ESPs with strong embedded engineering and offshore capabilities could benefit from large deals, but intense competition and cost pressures may impact pricing in new contracts.
Overview on weak demand outlook
Kotak Equities lowered revenue growth estimates for KPIT, TELX, and TTL for FY2026-27E due to delayed pipeline conversion and JLR exposure, cutting earnings by 4-13 per cent and FVs by 5-21 per cent. EBIT margins, meanwhile, are reduced by 30-140 bps. It, however, kept estimates for Cyient (DET) unchanged, but lowered the target PE multiple to 17X (from 20X) for the DET segment due to limited ability to benefit from the upcycle in spending given portfolio challenges.
LTTS reasonably positioned with presence across industries and healthy large deal wins
Kotak said that LTTS is reasonably positioned with presence across industries and healthy large deal wins. “LTTS has many leadership attributes such as—(1) a comprehensive range of service offerings to address the product life cycle journey of clients, (2) multi-vertical industry expertise—diversification helps in absorbing shocks in one segment and (3) longstanding quality customer base. The company’s recent investments to strengthen large deals capabilities have shown some early signs of promise. The company announced a $200 million large deal TCV across eight large deals in Q3FY25. It has followed it up with a $80 million TCV deal in the industrial products segment, setting it up for another strong show on order bookings and some improvement in organic revenue growth in FY2026,” the Kotak report stated. Even so, the brokerage firm said that some of the benefit would be offset by weakness in auto and ramp-down in a few engagements. “We expect 11.3 per cent organic c/c revenue growth in FY2026,” it said.