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Navigating headwinds

Demand uncertainties from 2HCY24 have trickled into CY2025E budgets, implying continued weakness in FY2026E. The demand pipeline has built up well at most ERD service providers with exposure to the automotive vertical. However, 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% decline in stock prices over the past three months. We upgrade LTTS to REDUCE (from SELL).

Healthy pipeline build-up but conversion stuck in a limbo

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 pipeline has built up to record levels across most Indian and European players, as more RFQs are floated by clients. The uncertainty around the medium-term strategy has impacted decision-making and as a consequence, conversion into the order book. The impact has been more severe for German OEMs and has percolated down to the spending outlook by these clients. Further, reprioritization has also led to some uncertainty in deal rampups. We believe spending would remain weak in 1HCY25, but the recovery is likely to be gradual, resulting in a weak growth outlook for the year.

Increased competitive intensity for large deals could pressure pricing

Overall auto OEM R&D spend growth would likely be modest in CY2025E. Further, auto OEMs have indicated a higher focus on increasing the efficiency of R&D investments and a shift to low-cost countries from nearshore locations. Select ESPs with strong capabilities in embedded engineering and offshore presence would benefit from large deal wins. The competition would be fierce given a modest increase in spending and a focus on spend efficiency by clients. These factors could impact pricing in new contracts.

Cut estimates across companies on weak demand outlook

We moderate our revenue growth estimates by ~1-2% for KPIT over FY2026-27E on a delayed pipeline conversion. We expect 16.5% yoy c/c revenue growth in FY2026E. TELX and TTL have higher exposure to JLR and a pullback in spending and the limited scale of relationships beyond the top client drive a 3% and 6% cut to our revenue growth estimates for FY2026E. We lower our EBIT margin estimates by 30-140 bps across KPIT, TELX and TTL over FY2026-27E, leading to a ~4-13% downward revision to our earnings estimates and ~5-21% lower FVs. Our estimates for Cyient (DET) remain unchanged, but we lower 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. We make minor tweaks to LTTS growth and margin estimates and keep FV unchanged at Rs4,750, valuing the company at 28X FY2027E EPS. We upgrade LTTS to REDUCE.

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