Warning lights flash for ER&D companies as auto sector runs low on fuel

ER&D downshifts on weak Q4, gloomy 2025; more downgrades loom

Pure-play engineering research and development (ER&D) firms lagged behind their information technology (IT) services peers in calendar year (CY) 2024, hit by US election-related uncertainty, weak demand across sectors, and delays in client decision-making. That underperformance may extend, with a soft January-March quarter likely and modest projections for CY 2025. ER&D stocks have already dropped over 20 per cent on average since early February.

 

Girish Pai of BOB Capital Markets says deceleration and no-growth risks are rising, and the Street hasn’t fully priced in the earnings downside. Tariff hikes — including retaliatory ones — and fiscal tightening in the US could force further earnings revisions even into 2026-27 (FY27), where the Street is still pencilling in a rebound.

 

For now, attention is on the January-March quarter numbers. Kotak Institutional Equities (KIE) expects steep revenue declines in the transportation vertical across Tata Elxsi (TELX), Tata Technologies (TTL), and L&T Technology Services (LTTS). Cyient, TTL, and TELX are expected to post revenue drops both sequentially and year-on-year.

 

LTTS is likely to report a seasonal uptick in organic revenue, while KPIT Technologies may see growth ease. Weak demand and broader sector worries are set to pressure margins and could weigh on what is typically a stronger April-June quarter. KIE has a ‘sell’ or ‘reduce’ call on all the ER&D firms it covers.

 

Given the cautious sentiment and earnings downgrades, the premium that ER&D leaders command over midcap IT names has narrowed — from a three-year average of 60 per cent to 15 per cent, according to Antique Stock Broking — and may compress further.

 

Within the ER&D space, brokerages flag higher risk for the retail and manufacturing verticals, including automotive, electronics, and chemicals, while other segments could see milder order slowdowns.

 

The automotive segment, already under strain from a tech shift and soft demand, now faces new challenges — a proposed 25 per cent tariff by the US and expected countermeasures from other countries. These could disrupt supply chains, raise costs, delay capital expenditure, and trigger steep volume drops.

 

In a recent note, KIE analysts led by Kawaljeet Saluja flagged rising caution among automotive original equipment manufacturers (OEMs) on R&D spending as policy risks compound demand uncertainty. Companies say peak investment is behind them, and Tier-I suppliers aren’t counting on better conditions in CY 2025. The Trump-era tariffs, they add, are likely to intensify short-term cost-cutting efforts. KIE sees limited scope for a quick recovery in deal pipelines, which could weigh on 2025-26 (FY26) prospects.

 

ICICI Securities has downgraded ER&D stocks, citing mounting concerns in the automotive sector. Analysts led by Ruchi Mukhija say the space remains under pressure from weak demand, Chinese OEM competition, and tariff-driven input cost spikes.

 

If the slump drags on, revenue growth could slip to high single digits in FY26-27 — a stark contrast to the over 20 per cent gains during the previous automotive upcycle.

 

ICICI Securities has downgraded Tata Elxsi to ‘sell’ from ‘hold’. It also cut TTL to ‘sell’ (from ‘add’), LTTS and KPIT to ‘reduce’ (from ‘hold’), and maintained a ‘hold’ on Cyient.