AI risks hit IT sector: Elara Capital downgrades TCS, Infosys and other stocks

Mumbai: The 2-week ceasefire between Iran and the United States led to a huge surge in the Stock Market on Wednesday. The Nifty 50 soared 3.78 percent, while the BSE Sensex rallied 3.95 percent. All indices recorded significant gains today, however, the Nifty IT index rose only 0.52 percent. The IT sector has been facing volatility of late. The Nifty IT index has recorded a decline of 5 percent over the past one year, 8.93 percent in six months, and 18.40 percent in the past three months. The concerns regarding AI has severely impacted the IT sector.

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In a big set back, brokerage firm Elara Capital has downgraded the share target price of several major IT companies. The brokerage predicted that AI poses a risk of revenue declines of 1-3% for IT companies in the near to medium term. Companies with high exposure to time and material (T&M) contracts may be particularly affected, it added.

The brokerage projected that companies with T&M contracts accounting for approximately 46-52%, the AI-driven productivity gains could directly impact their revenue. The estimates are that companies with approximately 50% of their business based on T&M contracts may record revenue compression of 1-3% at the portfolio level.

Elara Capital sees no significant improvement in margins in the near term, as the IT industry is rapidly moving from an effort-based model to a non-linear growth model. The brokerage believes that hiring in the IT companies will no longer be directly linked to revenue growth, as firms are now focusing more on productivity metrics like employee engagement than revenue.

Furthermore, last 12 months (LTM) attrition has already reached multi-year lows, and most companies are operating at high utilisation levels, limiting the scope for margin expansion. Despite, subcontracting costs going down, it will not be sufficient to significantly improve margins in the near term, it said.

IT Companies share price target