IT Sector Q1 Earnings Preview: PL cuts ratings on Infosys, Mphasis; TCS among top picks

IT Sector Preview: The Indian IT services sector is likely to post a subdued performance in Q1FY26 despite it being a typically strong quarter, according to Prabhudas Lilladher (PL). In its quarterly preview report, PL said that ongoing caution among global enterprises, weak demand in tariff-impacted verticals, and limited operating leverage could drag down earnings momentum across the board.

Modest Revenue Growth and Margins Under Pressure

“We expect median revenue to decline by 1.2 percent quarter-on-quarter in constant currency (CC) terms, and grow only 0.5 percent QoQ in USD terms,” PL said. This weak growth is attributed to sluggish demand recovery, particularly in tariff-sensitive segments, and the deferral of compensation hikes by most companies.

According to PL, cross-currency movements will offer some relief, with the euro and pound strengthening 5.9 percent and 7.6 percent QoQ, respectively, against the dollar. This is likely to translate into reported tailwinds of 60-400 basis points, depending on the company’s exposure.

Despite this, PL anticipates flat to negligible improvements in margins, given the lack of strong revenue momentum. "The improvement in margins would be marginal due to missing operating leverage," PL added.

Vertical and Stock-Specific Outlook: TCS, Infosys, Mphasis in Focus

From a vertical standpoint, PL expects BFSI to sustain growth, while sectors like hi-tech and energy/utilities may offer selective tailwinds. However, performance in manufacturing and consumer-facing segments, including automotive and retail/CPG, is likely to stay soft.

"We remain positive on TCS, Infosys, Mphasis, and Persistent Systems (PSYS), which are less dependent on discretionary spending and relatively shielded from tariff-linked disruptions," PL noted. However, given recent rallies, PL revised its ratings — Infosys has been downgraded to 'Accumulate' from 'Buy', while MPHL and PSYS have been moved to 'Hold' from earlier 'Buy' ratings.

Tier I & II Companies: Widespread Sequential Declines Expected

Among Tier I IT firms, PL expects a median revenue decline of 0.7 percent in CC terms, with only LTIMindtree, Mphasis, and PSYS expected to post sequential growth. For Tier II companies, the median revenue fall is forecast at 2.5 percent, with names like Tata Elxsi and Tata Technologies bearing the brunt due to weakness in automotive demand.

Margins are expected to compress for both groups, albeit cushioned by currency tailwinds. "Median EBIT margin for Tier I companies is likely to contract by 40 basis points QoQ to 17.3 percent, while Tier II firms may see a 20 basis points drop to 15.4 percent," PL said.

Valuation Concerns Prompt Downgrades

Despite the muted Q1 outlook, IT stocks have seen a significant rally in recent sessions. "The 1-year forward P/E multiples for Tier I and II IT stocks are trading at 25x and 33x, respectively — a premium to their 10-year average, suggesting valuations are stretched," PL highlighted.

Given this backdrop, PL said upside potential is limited and any further rerating would require a clear revival in demand or strong earnings surprise. “We believe the pace of transition from early-stage experimentation in AI to actual production remains slow, with many companies yet to see meaningful ROI,” the brokerage added.

In conclusion, as Q1FY26 earnings season unfolds, Indian IT firms are staring at a soft quarter marked by weak demand, modest revenue, and margin headwinds, as per Prabhudas Lilladher. While pockets of resilience exist in firms like TCS and Infosys, the broader sector remains vulnerable to global uncertainty and cautious spending. With valuation premiums already baked in, PL believes investors should remain selective, keeping an eye on execution and deal wins in the quarters ahead.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.