ER&D companies may face further pressure after KPIT Tech's share rout

KPIT Technologies' weak outlook reflects slowing demand from European automakers, raising concerns over earnings and growth prospects for the broader engineering R&D sector

A profit warning by KPIT Technologies (KPIT) triggered a big selloff in the stock. It also has negative implications for other players with exposure to the engineering, research and development (ER&D) space, such as L&T Technology Services, Tata Elxsi, Cyient and Tata Technologies. 

The shares of all these companies lost ground in the past month and saw sharp selloffs following KPIT’s 17 per cent fall on Wednesday. 

KPIT indicated deterioration in business momentum during Q1FY27 due to actions by some European automakers or original equipment manufacturers (OEMs). They also gave profit warnings and adverse business outlook. 

KPIT indicates that Q1FY27 performance will be materially below earlier expectations due to sudden drop in revenue during the last few weeks, following adverse warnings by European OEMs. 

KPIT expects 1 per cent year-on-year (Y-o-Y) decline in dollar terms the reported revenue in Q1FY27 and operating profit and net profit margins are expected to fall quarter-on-quarter (Q-o-Q), disproportionately higher than the revenue decline. 

The management believes the weakness is temporary and expects clients’ cost-cutting initiatives will accelerate outsourcing and artificial intelligence (AI)-led automation over the long term. 

A dollar revenue decline of 1 per cent Y-o-Y, implies about 4 per cent constant currency decline on a sequential basis. The concerned clients probably include BMW, Mercedes Benz and Volkswagen. 

BMW is KPIT’s largest client, contributing 12 per cent of the top line. The short time period gives little opportunity to impose cost controls. Hence, KPIT expects sharp declines in earnings before interest, taxes, depreciation and amortisation (Ebitda) and net profit margins Q-o-Q in Q1FY27. 

The management said the significance of the impact was only realised recently. As a result, FY27 may be a soft year for pure-play ER&D players and the implications may even extend beyond, to FY28. 

H1FY27 will remain unsatisfactory but KPIT believes growth continues to be driven by products and solutions, trucks & off-highway, and the US, South Korea and India markets, while passenger vehicles are supported by new client additions. 

Given the weak Q1FY27 and no visibility of growth until Q4FY27, this could mean FY27 will see Y-o-Y revenue decline. FY26 revenue was down 1.4 per cent compared to FY25. 

Investments in autonomous, after-sales and full vehicle engineering continue to witness traction. KPIT is also implementing AI-led productivity improvement and cost-containment initiatives while investing in AI-led products and solutions. It expects profit growth during H2FY27 with strong Q-o-Q growth in Q4FY27. 

KPIT has historically commanded premium valuations owing to its consistent sector-leading growth. 

It remains well positioned to benefit whenever outsourcing increases. But there may be further near-term earnings downside.

The situation may have arisen due to cyclical slowdowns and tough macro conditions triggered by the Iran war and its impact on energy and commodity prices, supply-chains breaks, and inflation. 

European auto companies are also facing tariff issues and competitive pressure from Chinese OEMs. 

KPIT is diversifying from passenger vehicles (PV) to trucks, off-highway, micro mobility segments, among others, and moving beyond Western and Japanese markets in search of clients. 

It is also developing AI-led solutions to retain clients by helping them to compete. It may invest 3-5 per cent of sales on R&D to develop its AI-led portfolio. 

Rather than cutting down the total addressable market, the current situation will extend timelines for KPIT’s growth and margin improvements. 

If the management is right in guessing that the current conditions will eventually trigger more outsourcing opportunities, there will be a rebound when that translates into visible revenues. 

Prior to the advisory, KPIT was discounted at price-to-earnings (PE) of 21 times its expected FY27 earnings. Earnings per share or EPS expectations are being cut by 15-20 per cent for FY27. 

Some analysts who have given reduce calls have also cut valuation multiples to around 17 times the FY27 PE. 

L&TTS, which also has high ER&D exposure, may see revenues flat or up slightly in Q-o-Q in constant currency terms as the process of client pruning and restructuring continues. 

The earnings before interest and taxes (Ebit) margin could rise marginally Q-o-Q. 

However, like all other companies in this space, the impact of the West Asia war on its business has been negative. 

The decision to sell SWC (a communications play) for cash worth ₹452 crore and focus on AI indicate transitional phase for the company.