IT Sector: Disruption Yields Opportunities

The Indian IT sector has endured a sharp 25% correction over the past three months, fuelled by investor fears that Gen-AI platforms like Claude (by Anthropic) and Palantir could upend traditional SaaS and IT services models. Yet the industry demonstrates resilience, contending that deploying these unproven technologies in complex, “brownfield” regulatory landscapes prove far more challenging than the hype implies. As noted in our December 2025 sector update, we initially pegged AI’s deflationary impact at ~4%, anticipating offsets from fresh deal wins. However, the recent Gen-AI product launches have intensified this narrative, lifting deflation to 6-7% and thrusting the sector into a phase of uncertainty and slow growth. Growth recovery now pivots on securing net-new deals, with renewals stagnating at subdued rates and pricing evolving from pure effort-based to effort-plus-agents structure. Success boils down to execution and AI prowess in outcome-driven settings. We stay constructive that the IT services model survives, with Gen-AI models ultimately unlocking net-new opportunities worth USD 300-400bn. Following the correction, valuations have reverted to pre-COVID levels; reverse DCF analysis shows current prices implying terminal growth of just 2-3% (versus prior 5-6%), alongside 10-year growth of ~4% for large caps and ~8% for mid-tiers. We thus trim FY27/28E revenue estimates by 2-3% and align multiples to pre-COVID levels for tier-1 firms. Our tier-1 picks: Infosys, Tech Mahindra, and HCL Tech. Mid-tier preferences: LTM, Mphasis, Birlasoft, and Sonata.

IT services navigating AI complexity: The gap between AI’s hype and the engineering required for enterprise-grade reliability is wide and difficult to bridge. Enterprises are moving past generic chatbots toward highly customized systems that must integrate perfectly with their unique data and workflows. To achieve the uptime and flawless performance that modern business demands, organizations will have to move ahead of greenfield experiments and start building a disciplined framework for AI orchestration. This shift fundamentally elevates IT service providers from simple implementers to vital strategic anchors, tasked with the high-stake management of security, cross-platform interoperability, and human-in-the-loop governance to mitigate the inherent unpredictability of large-scale models. We are still in the foundational era of this transformation; consequently, the ultimate winners will be those who move beyond the novelty of generative tools to build rigorous, governed, and scalable engines capable of driving sustainable, long-term growth.

Reverse DCF implies limited downside: The tier-1 IT stocks have corrected by ~20-22% and mid-tier IT has corrected by ~25-30% over the past two months. We have done a reverse DCF to identify growth rates the stocks are factoring in after the steep correction. The tier-1 companies are now trading at an average multiple of 16.4x FY27E, which is at 20% discount to the 10-year average multiples and similar to the 10Y pre-covid average multiples (FY10-20). The current prices factor in USD growth rate of ~4.9% over a 10-year period (FY25-35E) and terminal growth rate of ~2.8% (vs ~5% earlier). The pre-covid 10-year USD revenue growth CAGR was ~11%, EPS CAGR was ~13%, and the P/E multiple was at 17x, resulting in PEG ratio of ~1.3x. The current PEG ratio for the tier-1 IT stocks is at 1.5x, considering a 6% revenue CAGR over FY26-28E. The target prices are based on a growth assumption of 5.8% for tier-1 and 8.6% for mid-tier IT with a WACC of ~11% and terminal growth rate of 5%.

AI is reshaping global enterprises capabilities: AI is fundamentally transforming the IT services sector by acting as a powerful productivity engine, with recent insights from the Infosys AI Day highlighting potential gains such as a 2.5x increase in developer velocity and a 40% reduction in overall engineering effort. Beyond mere internal efficiency, this shift creates significant new service frontiers, allowing firms to pivot toward high-value offerings in AI strategy, agentic engineering, and large-scale digital modernization. These capabilities empower IT providers to aggressively tackle decades of accumulated technical debt, such as accelerating the migration of legacy COBOL systems to modern microservices by up to 60% compared to traditional approaches. By embedding AI into daily operations—from faster incident resolution to dramatic cuts in support costs—IT organizations are successfully shifting their focus away from simple, defensive cost-optimization toward proactive, strategic growth that fundamentally redesigns both business and engineering processes for the future.

Middle East war impact: The ongoing Middle East crisis poses a moderate short-term risk to Indian IT firms with exposure to regional energy and utility clients. Geopolitical uncertainty may delay discretionary spending and new projects, while raising operational concerns regarding infrastructure resilience, travel, and employee safety. Major firms like TCS (6%), Infosys (13%), HCLTech (9%), Wipro (16%), and Birlasoft (17%), which derive ~6-17% revenue from the Energy & Utilities sector, are particularly watchful. However, the impact on existing projects is expected to remain contained, as most delivery operations are anchored offshore in India and mission-critical programs typically persist despite regional volatility.

Re‑rating to pre‑COVID valuations: The US consumer confidence Index has fallen 17% below the 10‑year average of 91.2 in Feb’26 (vs its lowest level of 85.7 in the past decade). Similarly, the US CEO Confidence Index, at 6.1, is 6% below its 10‑year average. The global software services and SaaS stocks have also faced a sharp sell‑off amid fears that rapid AI advancements could materially disrupt the business model. Nifty IT index has underperformed, declining ~25% over the past three months and 13% over the past one month, led by AI-induced disruptions narrative. The Nifty IT Index is trading at a PE of 17.7x 1Y forward earnings, which is ~18% below its 10-year historical average but only 3% higher than the pre-covid 10-year average multiple. Large‑cap IT companies are valued at roughly 14.7x FY28E earnings, while mid‑caps trade at 16.3x. We are reducing our valuation multiples by ~20% across the coverage universe. We cut the Tier -1 FY28E revenue/EPS estimate by 4/3% and mid-tier revenue/EPS by ~3/2%. The USD INR assumption is reset to INR 91.5/92.5 for FY27/28E.