Not just TCS: Q1 results destroy midcap IT's last standing heroes

Economic Times

5 days ago

The darling status of India's midcap IT companies is evaporating faster than their stock prices, as investors who fled largecap IT bellwethers for supposedly safer harbors discover there's nowhere to hide in the sector's brutal downturn. While Tata Consultancy Services (TCS) has grabbed headlines with its 12,000-employee layoff plan and share prices being down one-third from peak, the once high-flying midcap IT stocks, previously shielded by their growth engine reputation, are also nosediving.
ADVERTISEMENT The Q1 earnings season proved to be a tough one for mid-tier IT companies, with most reporting topline misses that sent investors scrambling for the exits. Having lost about 10% in a week, Persistent shares are in bear grip and down about 24% from peak. Coforge shares have also lost about 7% of its value in the last one week alone.
"Q1 results triggered a sharp stock correction for most of the mid-tier IT companies," said HSBC India's Yogesh Aggarwal. "Every company print was interesting, with some idiosyncratic take-away."
The grim reality: even companies posting what appeared to be decent numbers couldn't escape punishment. Mphasis "finally reported a sharp decline in its top logistic client" but somehow also delivered "strong growth and extremely strong deal wins".
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Capital intensity is spiking across midcap IT as companies leverage their balance sheets to win fixed-price contracts. Coforge sits at the epicenter of this debate, with its free cash flow to revenue conversion averaging a mediocre 5% in recent quarters.
ADVERTISEMENT "Most companies are leveraging their balance sheets to offer better terms for fixed-price contracts," Aggarwal warned, highlighting how desperate the competition has become.The cash conversion crisis isn't isolated to Coforge. Persistent has seen similar increases in contract assets leading to weaker cash conversion, while even Mphasis reported the troubling trend in Q1.
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Despite the carnage, some analysts are doubling down on beaten-down names. Jefferies upgraded Mphasis to BUY, arguing that "the key overhang in logistics vertical is behind" and raising their price target to Rs3,100 based on "an improving growth outlook."
ADVERTISEMENT For Coforge, Jefferies maintained its BUY rating with a raised price target of Rs2,030, expecting the company to deliver 23% EPS CAGR over FY26-28 despite current struggles.But Vinit Bolinjkar, Head of Research at Ventura Securities, struck a more cautious tone: "The Q1 FY26 earnings season proved challenging for midcap IT companies in India, despite initial investor preference for them over large-cap IT firms."
ADVERTISEMENT The pain isn't just domestic. Weak discretionary spending as clients in the US and Europe delay IT projects amid trade and inflation uncertainties is crushing revenue conversion. "Deal pipelines remained robust, their conversion into revenue was slow, particularly impacting sectors like manufacturing, auto, and consumer packaged goods," Bolinjkar explained.A notable trend this quarter was the role of cross-currency tailwinds, especially due to appreciation in currencies like the Euro and British Pound, which boosted reported USD revenue growth. 'However, this partly masked the underlying weakness in volume-led business. On the profitability front, operating margins came under pressure across most firms, driven by wage hikes, higher visa-related costs, and relatively soft topline growth. Despite this, some companies demonstrated effective cost control measures through higher utilization rates, reduced subcontracting, and disciplined hiring,' said noted Anil Rego, Founder & Fund Manager of Right Horizons PMS.The sector's elevated valuations are becoming impossible to justify without an earnings upgrade cycle. "The Nifty IT index, encompassing many midcap firms, had surged significantly, trading at a premium to its long-term average," Bolinjkar observed. "Without a clear earnings upgrade cycle, these elevated valuations appear difficult to justify."Even after recent corrections, some midcap IT stocks might still be considered stretched given the current growth outlook, a sobering assessment for investors who thought they'd found safety in the sector's supposed growth engines.'The outlook for midcap IT in the next few months appears mixed, with potential for continued pressure but also some pockets of resilience. Q1 FY26 results indicate a subdued start for the Indian IT sector, a trend likely to persist for midcap players. Most IT firms are maintaining cautious guidance, with largecaps like Infosys revising its FY26 revenue growth guidance to a modest 1-3%, reflecting a challenging demand environment. The lack of clear guidance from some large players further underscores this cautiousness for midcap players,' Bolinjkar said.However, most companies remain guarded in their short-term outlook but are optimistic about a recovery in H2FY26, as client budgets stabilize and deferred projects start ramping up.The sector appears to be in a consolidation phase, with performance divergence expected to continue across players, Rego sums it up.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of the Economic Times)
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