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Macro pressures intensify; growth recovery still elusive

* We expect demand commentary to remain soft into 2QFY27, despite it being a seasonally strong quarter, as macro pressures, interest rate hikes, AI-related disruptions, and geopolitical overhang continue to weigh on discretionary spending and decision-making cycles. Against this backdrop, we do not expect QoQ growth acceleration across our coverage universe in 2QFY27, with softness likely to extend into 3QFY27 due to furloughs as well.

* A weak 1Q, followed by a subdued 2Q, would translate into a weaker 1HFY27 on a YoY basis. With 1H tracking below the run-rate required to sustain the upper end of FY27 guidance, the ask from 2H to bridge the gap becomes increasingly impractical. If 2Q revenue performance is weaker than our estimates, we could see some guidance cuts. We expect HCLT to maintain its FY27 guidance due to better deal visibility. INFO may lower the upper end of its FY27 organic growth guidance by 25bps (which is (0.2)%-1.3% organic YoY CC currently) if 2Q performance is below expectations.

* 2QFY27 results are likely to mirror the tepid macro environment, with QoQ CC growth expected in the range of -0.5% to 3.0% for large-caps. Mid-caps are expected to outperform once again, with growth ranging from 0.0% to 12.0%, led by continued large-deal ramp-ups and inorganic contribution in some cases. For our coverage universe, we expect aggregate revenue/EBIT/PAT to grow 12.8%/13.6%/13.4% YoY (all in INR terms), respectively.

* Margins are expected to remain range-bound for most players, with TCS, HCLT, Wipro, and LTM expected to see sequential improvement, supported by the reversal of wage hike impacts and cost measures, along with usual 2Q seasonality in the case of HCLT. INFO and TECHM are expected to remain broadly flat. Persistent (PSYS) is expected to see margin contraction following wage hikes, while MPHL, HEXT, and ZENT are expected to see moderate expansion as companies continue to invest in growth, capabilities, and AI. COFORGE is expected to remain flat due to residual Encora integration costs.

* We expect modest cross-currency headwind of ~10-30bp for most companies.

* Vertical performance in 2Q: Across the sector, BFSI is expected to remain the key growth driver, supported by steady deal conversion and resilient spending, with Hi-Tech also expected to remain stable. HLS, Aerospace, and E&U are expected to see selective growth, supported by deal execution and AI-led engineering. Consumer, Telecom, and Travel & Transportation are expected to remain under pressure, with discretionary spending weakness continuing to weigh on demand.

* Despite the meaningful correction in valuations, we believe a sustained rerating will require evidence that demand is improving, revenue growth is accelerating, and companies can demonstrate that AI-led opportunities are beginning to offset productivity-related headwinds. We continue to prefer bottom-up ideas with better earnings visibility and execution. HCLT and TECHM in large-caps and COFORGE in mid-caps are our preferred picks.

Growth expectations across our coverage

* We expect a mixed 2QFY27 for large-cap IT. HCLT, INFO, and TECHM should lead large-cap growth at 3.0%, 1.8%, and 1.7% QoQ CC, respectively, supported by acquisitions, while Wipro is expected to be the only large-cap to decline 0.5% QoQ CC despite inorganic contribution during the quarter. TCS is likely to report moderate revenue growth of 0.5% QoQ CC, while LTM’s revenue growth of 0.9% QoQ CC was impacted by the Middle East disruption.

* Among mid-tier firms, we expect COFORGE to lead with ~12% QoQ CC growth (3.5% organic) due to contribution from the Encora acquisition, followed by PSYS (~5.0%), MPHL and HEXT (~3.0%), and ZENT (2.4%).

* Among ER&D names, we expect a gradual recovery to continue. Cyient DET will lead the growth with 4.3% QoQ CC (0.2% organic), driven by contribution from the TAO Digital Solutions acquisition. LTTS, Tata Elxsi, and Tata Technologies will report QoQ CC growth in the range of 1.7-2.2%, supported by continued large deal ramp-ups. KPIT is expected to report flat QoQ CC growth as weakness in European OEMs is offset by growth in the US and SIMA.

* Cross-currency impact for the quarter: On average, we expect ~10-30bp crosscurrency headwinds for our coverage companies on a sequential basis.

Valuations remain cheap, but returns to be muted in the near term

* Stocks are now inexpensive, with Tier-I valuations ~25%/33% below their 10- year/5-year averages. TCS and INFO are trading around -1 SD P/E levels and ~44%/39% below their 10-year averages, while TECHM and HCLT are trading closer to their 10-year averages. In contrast, Tier-II valuations are ~15% below their 10-year average, showing clear outperformance vs their larger peers.

* While valuations appear attractive, returns are expected to remain capped in the near term as deflationary pressures persist, AI-led implementation use cases take time to scale, and ongoing geopolitical tensions and higher interest rates weigh on valuations and stock returns.

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