Tech
India’s IT Sector Faces AI Disruption: Jefferies Sounds the Alarm
India’s IT services sector is bracing for significant structural changes driven by the rapid advancement of artificial intelligence (AI), according to a recent report from Jefferies. While IT stocks have seen a year-to-date increase of around 16%, the brokerage warns that the potential impact of AI presents unfavorable risk-reward dynamics.
AI’s Impact on IT Business Models
Jefferies predicts that AI will reshape revenue streams within the IT sector, shifting focus from traditional managed services towards consulting and implementation work. This transition isn’t without its challenges, potentially leading to increased revenue volatility and demanding significant adjustments to talent acquisition and operational strategies. The brokerage highlights that the impact of AI is “not over yet,” as reflected in their report title: “P(AI)n Not Over Yet. Stay Selective.”
Downgrades and Selective Picks
The analysis prompted Jefferies to revise its ratings on several key players. Infosys, HCLTech and Mphasis were downgraded to ‘Hold’, while TCS, LTIMindtree, and Hexaware received ‘Underperform’ ratings. Wipro already held an ‘Underperform’ designation. Despite the cautious outlook, Jefferies identified Coforge, Sagility, and IKS Health as preferred picks, recognizing their potential to navigate the evolving landscape.
Deflationary Pressures and Valuation Reset
A key concern raised is the potential for deflation in application managed services, which currently constitute a substantial portion (22–45%) of revenue for major IT firms. As AI tools become more sophisticated, they are expected to drive efficiency gains, potentially leading to pricing pressure. This contributes to a broader “valuation reset” impacting the Indian IT sector.
Mid-Cap IT Firms: A Brighter Spot?
Jefferies adopts a selective approach, favoring mid-sized IT firms due to their higher earnings growth potential and greater agility in adapting to AI-led changes. The brokerage estimates current stock prices imply revenue growth of 6–14% for large IT firms and 9–17% for mid-sized players over FY26–36. While acknowledging these assumptions are below historical averages, they believe further valuation compression is possible.
In a downside scenario, stocks could face further derating of 30–65% if revenue growth slows sharply. Conversely, mid-sized companies may have better rerating potential.
Nifty IT Index Performance and Investor Sentiment
The Nifty IT index has already experienced a decline of approximately 14%, underperforming the Nifty 50, signaling investor concerns about the impact of AI on core services. The recent third-quarter results, while initially positive, have shifted investor focus towards the medium- and long-term implications of AI.
Sector Earnings Outlook
Jefferies forecasts a sector earnings CAGR of around 6% during FY26–28, with Coforge, Sagility, and IKS Health expected to outperform with growth rates of 19–25%. This reinforces the preference for mid-sized firms capable of capitalizing on the opportunities presented by AI.
Frequently Asked Questions (FAQ)
Q: What is Jefferies’ main concern regarding the Indian IT sector?
A: Jefferies is primarily concerned about the structural changes AI will bring to business models, potentially impacting revenue streams and valuations.
Q: Which IT firms does Jefferies recommend?
A: Jefferies recommends Coforge, Sagility, and IKS Health as preferred picks.
Q: What is the potential downside risk for IT stocks?
A: In a downside scenario, stocks could face further derating of 30–65% if revenue growth slows significantly.
Q: Why are mid-sized IT firms favored?
A: Mid-sized firms are seen as more agile and better positioned to adapt to the changes driven by AI.
Did you know? The brokerage expects application managed services, a significant revenue source for large IT firms, to face deflationary pressures as AI tools improve.
Pro Tip: Investors should focus on companies demonstrating a clear strategy for integrating AI into their service offerings and adapting their talent base accordingly.
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