The IT services sector is facing uncertainty as demand fluctuations from the second half of 2024 are trickling into 2025 budgets, according to a report by Kotak Institutional Equities (KIE). This trend is expected to persist into FY2026, impacting the industry’s overall performance. While many engineering research and development (ERD) service providers, particularly those engaged with the automotive sector, have seen a solid demand pipeline, the decision-making delays among German original equipment manufacturers (OEMs) are hindering conversion rates.

Demand Outlook and Conversion Challenges

The analysis reveals that automotive manufacturers are currently reassessing their investment strategies to align with changing market demands. KIE notes, “Although spending related to new platform development remains stable, OEMs face a pivotal decision: to concentrate on electrification or to invest in alternative powertrains like hybrids and internal combustion engines.” The necessity for innovation in technology is recognized among auto OEMs to maintain competitiveness.

Despite an increase in Requests for Quotation (RFQs) from clients, the uncertainty surrounding medium-term strategies is causing delays in decision-making, impacting the conversion of leads into actual orders.

Impact on German OEMs and Future Spending

The report highlights that the consequences of these delays are particularly pronounced among German OEMs, leading to a pessimistic outlook for their spending. KIE anticipates that H1 2025 will likely see subdued spending, with gradual recovery expected. This situation contributes to a tepid growth forecast for the year.

• Key Insights on Spending Trends:
  • Anticipated modest growth in R&D spending within the automotive sector in 2025.
  • A shift of investments to lower-cost countries as manufacturers focus on operational efficiency.
  • Embedded engineering and offshore capabilities could provide an edge for engineering service providers (ESPs) in securing large deals, although competitive pressures may squeeze pricing.

Adjusted Revenue Predictions and Earnings Estimates

In light of the ongoing challenges, Kotak Equities has revised its revenue growth forecasts for companies like KPIT, TELX, and TTL, citing delayed pipeline conversions and exposure to Jaguar Land Rover (JLR). Earnings estimates have been trimmed by 4-13%, and forecasts for fair value have been adjusted downward by 5-21%. Meanwhile, EBIT margins have been reduced by 30-140 basis points.

Although estimates for Cyient (DET) remain stable, Kotak has lowered the target price-to-earnings multiple to 17X from 20X, reflecting the company’s limited capacity to capitalize on spending upswings due to ongoing portfolio challenges.

LTTS: A Bright Spot Amid Challenges

LTTS stands out as a company well-positioned across various industries, bolstered by significant deal wins. KIE acknowledges LTTS’s strengths, such as:

• A comprehensive array of services that cater to the entire product lifecycle.
• Diverse industry expertise, allowing the company to withstand shocks in any single market segment.
• A solid and established customer base.

The company recently reported a substantial $200 million total contract value (TCV) across eight large deals in Q3 FY25, followed by an $80 million TCV deal in the industrial products sector. This positioning suggests a potentially positive trajectory in order bookings and organic revenue growth for FY2026. However, KIE cautions that weaknesses in the automotive sector and declines in certain engagements may temper some of these benefits. They project an 11.3% organic year-over-year revenue growth for FY2026.

In conclusion, while the IT services landscape is grappling with demand uncertainties and competitive pressures, companies like LTTS are leveraging their strengths to navigate these challenges effectively.