Whalesbook
Indian IT Sector Navigates Q3 Weakness, Eyes AI-Driven CY26 Rebound
Indian information technology services firms are bracing for a subdued December quarter (Q3FY26), according to a recent report by Motilal Oswal. The sector is anticipated to experience typical seasonal softness, primarily due to widespread furloughs and recent wage increases, which are expected to weigh on growth across major companies. However, the report highlights that the market's attention is increasingly moving beyond these near-term challenges to anticipate the significant demand surge expected from Artificial Intelligence (AI) spending in calendar year 2026.
The Core Issue
Motilal Oswal projects that large IT companies will likely report modest sequential constant-currency (cc) revenue growth ranging between 0.3 per cent and 2.3 per cent for Q3FY26. Mid-cap IT firms are expected to show stronger performance, with growth anticipated between a 2.5 per cent decline and a 3.5 per cent increase. On an aggregate level, the sector's revenue is estimated to grow 7.7 per cent year-on-year in rupee terms, with Earnings Before Interest and Taxes (Ebit) and Profit After Tax (PAT) projected to increase by 7.2 per cent and 7.6 per cent, respectively.
The overall demand environment remains cautious, influenced by global economic uncertainties, potential tariff-related risks, and the ongoing transition to a new technology cycle. Clients are exhibiting hesitation in committing substantial incremental spending towards large transformation projects, leading to demand described as "steady at best" until budget cycles reset around January 2026.
Vertical Trends Mixed
Specific industry verticals show varied outlooks. The Banking, Financial Services, and Insurance (BFSI) sector is expected to remain relatively resilient despite potential disruptions. Demand from the Hi-Tech segment is likely to be flat, as several significant deals are currently in a transitional phase. The Travel and Transportation sector should benefit from the ramp-up of ongoing deals. In contrast, the manufacturing sector presents a mixed picture, with auto-related spending under pressure, although core industrial segments are showing stability. Engineering Research and Development (R&D) services are expected to remain stable in Q3, with a notable recovery anticipated in the subsequent March quarter.
Company-Specific Performance
At the individual company level, Motilal Oswal forecasts Infosys and Tata Consultancy Services (TCS) to post modest sequential cc growth of 0.3 per cent and 0.5 per cent, respectively, reflecting the seasonal headwinds. HCL Technologies is projected to outperform its large-cap peers, with an estimated Q-o-Q cc growth of around 2.3 per cent, partly aided by seasonal strength in its software business. Wipro is expected to achieve approximately 1.5 per cent growth, bolstered by inorganic contributions from its acquisition of Harman. Tech Mahindra and LTIMindtree are anticipated to report growth of around 0.5 per cent and 2.2 per cent, respectively, with the latter benefiting from significant deal ramp-ups.
Among mid-cap IT firms, Persistent Systems is expected to lead with robust Q-o-Q cc growth of about 3.5 per cent. Coforge and Mphasis are projected to deliver 3.0 per cent and 1.3 per cent growth, respectively. Hexaware Technologies might experience a sequential decline, attributed to lower license revenues and seasonal furloughs.
Margins Under Pressure
Profitability margins are likely to face pressure during the December quarter. This is primarily due to the impact of wage hikes and the ongoing furloughs. Motilal Oswal anticipates sequential margin declines for TCS and Wipro. Infosys's margins may remain flat, as potential cost savings could be offset by increased investments in new capabilities. HCL Technologies and Tech Mahindra are expected to see some margin expansion, supported by ongoing cost optimization efforts and improvements in project execution. Within the mid-cap segment, Coforge and Hexaware could face margin compression, potentially ranging from 60 to 70 basis points.
AI Cycle Key to CY26 Outlook
Looking beyond the current quarter, Motilal Oswal believes that enterprises are progressively moving from initial AI pilot projects to more scaled deployments. This transition is expected to bolster the deal pipeline stability and enhance the total contract values for IT companies over time. The sector is actively increasing investments in AI-centric capabilities through strategic acquisitions and partnerships, positioning themselves effectively for the next wave of demand.
The brokerage forecasts AI services demand to experience a meaningful uplift starting mid-2026. This is projected as hardware-led AI capital expenditure moderates and spending shifts towards software, platforms, and associated services. Calendar year 2026 is viewed as the bottoming point of the current growth cycle, setting a positive foundation for stronger acceleration in the subsequent years.
Motilal Oswal Top Picks
Motilal Oswal maintains its top stock recommendations within the IT sector. For large-cap companies, their preferred picks are Infosys and Tech Mahindra. In the mid-cap space, Coforge and Hexaware Technologies are highlighted. Infosys is favoured for its significant discretionary spending mix and strong positioning in enterprise-wide AI initiatives. Tech Mahindra is backed for its ongoing execution improvements and ongoing business transformation efforts. For mid-caps, Coforge's robust order book and Hexaware's strategic gains from vendor consolidation underpin the positive outlook.
Impact
This news has a significant impact on the Indian stock market, particularly on the IT sector. Investor sentiment towards IT stocks may remain cautious in the short term due to Q3 expectations but could strengthen with the long-term AI outlook. This could influence investment decisions and portfolio allocations for Indian investors. The sector's performance directly affects India's export revenues and economic growth.
Impact Rating: 8/10
Difficult Terms Explained
- Seasonal furloughs: Periods when companies temporarily reduce operations or staff work, often during holiday seasons, impacting billable hours and revenue.
- Constant-currency (cc): A method of reporting financial results that excludes the effects of foreign exchange rate fluctuations, providing a clearer view of underlying business performance.
- Ebit: Earnings Before Interest and Taxes. A measure of a company's profit before accounting for interest expenses and income taxes.
- PAT: Profit After Tax. The net profit remaining after all expenses, including taxes, have been deducted.
- BFSI: Banking, Financial Services, and Insurance. A broad category of financial institutions.
- Basis points: A unit of measure used in finance to describe small percentage changes. 100 basis points equal 1 percent.
- Discretionary-heavy mix: Refers to a company's revenue primarily coming from services or products that clients can choose to purchase or defer, rather than essential services.
- Vendor consolidation: The process where a client company reduces the number of its suppliers or service providers to a select few, often to streamline operations and reduce costs.