Infosys, TCS, TechM, Coforge, Hexaware: Why Kotak prefers these 5 large, midcap IT stocks

Kotak Institutional Equities in a note on IT sector said Infosys Ltd, Tata Consultancy Services (TCS) and Tech Mahindra Ltd are its preferred picks among Tier 1 IT names, citing cheap valuations. It has Coforge ltd and Hexaware as its top picks in the in mid-tier segment. The domestic brokerage said the prevailing stock prices of Infosys, TCS and TechM reflect low growth expectations. 

These stocks, it said, trade at 16 times anticipated FY2028 earnings and are available at 4-5 per cent payout yield and 5-6 per cent free cash flow (FCF) yield.

"TechM has the potential to consistently grow above industry growth. Coforge and Hexaware trade at inexpensive valuations of 18 times and 17 times FY2028 earnings, respectively. We change the rating of Persistent Systems to Reduce from Sell, taking into account the reduced downside to our fair value.

Kotak said it is baking in higher Gen AI-driven revenue deflation in FY2027-28E, noting increasing risks even as the current adoption rates align with its expectations. It sees the weak transmission of tech spending growth to services to continue leading to moderate industry growth in the next several years. 

"We bake in higher disruption risks in the future by increasing the cost of equity assumption by 50-100 bps. These together drive cuts in fair values for companies under our coverage. We expect IT services to remain relevant in the long term and do not change our terminal growth assumptions. Quality challengers can have a leg up over incumbents. Prefer Infosys, TCS and TechM among Tier 1 names, with Coforge and Hexaware among mid-tier. Upgrade the rating of Persistent to REDUCE from SELL," it said.

Kotak estimated 3-3.5 per cent revenue deflation for the IT services industry in FY2027-28E. This is against an expectation of 2-3 per cent deflation earlier. The faster pace of innovation, focus on automating software development by key AI labs, high rate of adoption by the developer community and AI-first mindset of enterprises make the upper end of the deflation range more likely, it said

It slightly tweaked Gen AI efficiency assumptions. The higher deflation assumptions drove 1-2 per cent cut in dollar revenue estimates for FY2027-28E, it said.

In the case of contact services BPO, Kotak said Indian pure-play BPO services companies benefited from increased outsourcing and offshoring of processes by clients. Some of this was from in-house G&A spends and more from share gains from competition. However, increased AI adoption by enterprises would increase the asks of the extent of productivity benefits to be passed back, impacting growth, it said.

"Efficiency measures would enable the companies to manage profitability in the immediate term. On the other hand, while industry-specific BPO would remain relatively less impacted, cost pressures of healthcare clients, specifically those with greater exposure to Medicare Advantage plans would be a drag on medium-term performance for companies such as Sagility," it said.

The brokerage maintained 'Buy' on Sagility and 'Reduce' on EClerx and Firstsource Solutions.