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Recovery stuck in second gear

We have argued earlier that discretionary spending could see a revival in select pockets like US Banking, Healthcare, and Hi-Tech, driven by three key factors: 1) the beginning of a rate cut cycle, 2) a business-friendly administration, and 3) the start of pre-GenAI spending.

Six months on, the landscape has shifted. The probability of US rate cuts has diminished, and heightened geopolitical/tariff risks are weighing on short-term stability for US and European enterprises. Sentiment has turned cautious from January to March, with enterprises adopting a "wait-and-watch" approach. While GenAI adoption is progressing, it is not yet moving the needle for IT services revenues. The focus has yet to shift away from capex, and clients are still not prioritizing services spending. This evolving backdrop makes forecasting discretionary spending in FY26 uncertain, and meaningful improvement over FY25 is no longer a given.

In this environment, we prioritize correct positioning over predictability, favoring bottomup transformation and margin-driven stories over top-down discretionary names. We reposition our ratings to reflect this: we downgrade Infosys to Neutral and Wipro to Sell, while we upgrade TechM to BUY. LTIMindtree and TCS remain preferred picks for their risk-reward balance, whereas HCL’s all-weather portfolio makes it relatively resilient. We also trim our growth estimates and reduce target multiples by 15%. Among midcaps, we retain our preference for growth-oriented mid-tier names, Coforge and Persistent, and see the recent correction as an opportunity to buy. We downgrade LTTS to Neutral due to valuation discomfort.

Discretionary recovery slower than expected

* Recent comments from EPAM, Globant, and Endava (Exhibit 4) have dampened hopes for a swift recovery in discretionary spending during 1HCY25. This contrasts with our earlier expectations (3QFY25 preview: Setting the stage for a CY25 revival), when channel checks indicated a revival in short-cycle deals.

* While higher-for-longer interest rates remain a headwind, the bigger concern is rising uncertainty. Clients are likely adopting a wait-and-watch approach as the new US administration's stance on tariffs, along with lingering geopolitical tensions, adds to the volatility and could take time to stabilize.

* While not yet apparent in earnings downgrades (Exhibits 5 to 12), we keep an eye out on earnings estimates for major US sectors.

Positioning, not predicting: We rejig our ratings to reflect uncertainty

* The short-term volatility is likely to delay discretionary spending recovery, prompting us to temper our expectations for a meaningful FY26 rebound, particularly for large-caps.

* We believe getting our positioning right may reap more rewards than predicting when clients resume spending.

* Our preference is for bottom-up transformation/margin recovery stocks, rather than names contingent on a top-down discretionary revival.

* Market expectations of 5-6% CC growth for Infosys could be at risk, and we see TCS coming in lower at ~3.5%. Wipro and Infosys (our EPS estimates are ~7-10% below consensus for Infosys/Wipro) face correction risk, leading us to downgrade our rating to Hold for Infosys and Sell for Wipro.

* While LTIM’s new CEO navigates a tough macro, recent corrections in TCS and LTIM improve their risk-reward. HCL’s "all-weather" portfolio remains attractive, and we retain BUY.

* We continue to like mid-tier growth names like Coforge and Persistent, which continue to deliver commendable 20%+ earnings growth, with the recent correction offering a good entry point.

Upgrade TechM to BUY

* We initially stayed on the sidelines due to concerns over the street’s 15% FY27 EBIT margin estimates, persistent weakness in communications, and the need to assess TechM’s BFSI strategy.

* Key changes: Street margin expectations are now more reasonable at 14% and the company’s BFSI performance has been impressive in the last few quarters with niche offerings. We believe TechM’s transformation remains relatively decoupled from discretionary spends (detailed upgrade thesis on page 7).

* Transformation under new leadership has only just begun, and sustained margin improvements appear achievable despite near-term headwinds, in our opinion.

* With mid-tier IT peers already operating at 14-15% margins, TechM has the potential to exceed these levels, supporting a longer runway for 15-20%+ EPS CAGR beyond FY27.

* Key catalysts ahead: Continued efforts to improve deal quality, right-sizing the workforce, reducing the avg. resource cost, recovery in telecom vertical and sustained TCV growth will be key markers to track in the next 12 months.

* Key risks: TechM’s reliance on communications and manufacturing is a risk: the communication segment has bottomed out and a sharp recovery looks unlikely, and TechM’s automotive ER&D exposure (albeit for US OEMs) is a key risk to growth in FY26E.

Large-cap valuations: Something’s got to give

* Almost all six large-cap IT services players today trade at the same valuations – we went back in history to see the last time this happened (Exhibits 22 to 26); TechM and HCL are certainly in uncharted territory, but Infosys and Wipro have not been able to sustain valuation parity in the past.

* We think this valuation setup favors TCS the most. While the growth has been poor over the past 2-3 years, the stock has corrected by 20% over the past six months, and has underperformed most large-cap IT names. As growth becomes uncertain across the board though, we believe TCS could be in business and margin expansion could lead to better or at-par earnings growth to other peers.

* Nifty IT P/E remains at elevated premium to Nifty P/E despite the recent corrections (Exhibit 27); its current premium of 37% is still higher than last 5 year average (which includes COVID highs).

Downgrade Infosys, Wipro on slower-than-expected discretionary revival

* Infosys (up 4% in last one year) and Wipro (up 8% in last one year) have outperformed TCS (down 13%) and Nifty IT (up 1%) during this period, as markets have priced in a recovery in discretionary spends in CY25.

* As this report argues, a conducive business climate in the US and rate cuts have been key assumptions, which look uncertain at least for the short term.

* We believe there are risks to street’s growth estimates, and accordingly, we downgrade Infosys to Neutral and Wipro to Sell.

* We would revisit our ratings if FY26 guidance surprises us.

Valuations and changes in estimates

* We tweak our growth estimates for FY26 (Exhibit 1). More importantly, we ascribe 10-15% lower multiples to all companies under our coverage to account for short-term uncertainty.

* We prefer HCLT, TechM and TCS in large-caps and continue to like Coforge and Persistent in mid-tier names. Coforge is the only company in our coverage with consistent earnings upgrades – the recent mega deal announcement reinforcing our view. We see the recent correction as an opportunity to buy. We downgrade LTTS to Neutral due to valuation discomfort

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