Tata Elxsi shares faced selling pressure on Wednesday, declining 2.5% to ₹5,649 from the previous day's closing price of ₹5,793, despite reporting strong third-quarter earnings that exceeded market expectations. The stock's decline highlights the ongoing concern over expensive valuations in the face of solid operational performance.

Financial Performance Overview

The company delivered a mixed but largely positive quarterly performance, with key metrics showing both growth and some areas of concern:

While net profit declined significantly by 29.7%, the company demonstrated strong operational efficiency with EBIT growing 17.4% and margins expanding substantially to 20.9% from 18.5% in the previous quarter.

Segment-wise Performance

The transportation business emerged as the primary growth driver, registering 7.7% sequential growth. However, other key segments faced challenges during the quarter:

CEO Manoj Raghavan attributed the decline in Media and Communications, and Healthcare and Life Sciences verticals to seasonal furloughs and delayed key deal awards at the quarter's end. He expressed confidence in recovery and growth for both verticals starting in Q4 of the current financial year.

Margin Expansion and Regional Growth

The software segment led the margin expansion story, with margins rising by 318 basis points, contributing significantly to the overall EBIT margin improvement. From a geographical perspective, Europe and the United States drove regional growth, indicating strong demand in these key markets.

Valuation Concerns and Market Sentiment

Despite the positive operational metrics, valuation concerns continue to weigh heavily on investor sentiment. The stock currently trades at 52 times price-to-earnings multiple, significantly higher than the Nifty 50's average of 22 times. Additionally, the relative strength index of 70 suggests the stock may be in overbought territory.

Analyst sentiment reflects cautious optimism, with 2 out of 51 analysts maintaining 'buy' ratings, 4 recommending 'hold,' and 12 suggesting 'sell' according to Bloomberg data. The average 12-month consensus price target of ₹5,051.06 implies a potential downside of 10.9% from current levels.

India's new labour codes have begun delivering significant financial impacts across the IT sector, with major companies reporting substantial one-time charges in their third-quarter results. The regulatory changes, which redefine wage structures and expand the base for employee benefits calculations, are forcing companies to recognise higher past service liabilities.

Major IT Players Report Significant Charges

The labour code implementation has created substantial financial adjustments across leading IT firms:

TCS and HCLTech Q3 Performance

TCS faced the largest impact with a one-time labour code provision of ₹2,128 crores, including ₹1,800 crores toward gratuity and ₹300 crores toward leave liabilities. Combined with legal and restructuring costs, the total profit impact reached ₹3,391 crores. Net profit came in at ₹10,657 crores, down 11.7% against street expectations of 6.6% growth.

HCLTech reported a labour code-related charge of ₹956 crores, resulting in net profit declining 3.77% compared to street expectations of 10.8% growth. The company posted a profit of ₹4,076 crores, missing estimates of ₹4,702.40 crores by approximately 13%.

Regulatory Framework Changes

The new labour codes mandate that wages constitute at least 50% of the cost to company (CTC), necessitating comprehensive restructuring of employee benefits. This includes recalculating provident fund and gratuity based on the revised wage structure, creating significant past service liabilities for employee-intensive IT services companies.

Both TCS and HCLTech emphasised these charges were non-recurring, with management guidance indicating recurring margin impact should be limited to 10-20 basis points, assuming no further regulatory changes.

Business Operations Remain Resilient

Despite the regulatory impact, underlying business performance showed strength:

HCLTech upgraded its service revenue guidance to 4.75-5.25% from earlier 4-5%, and revised FY26 revenue growth guidance to 4-4.5% in constant-currency terms.

Market Impact and Future Outlook

Brokerages warn of structural cost implications, with Jefferies estimating that a 2% increase in Indian employee costs could reduce FY27 earnings by 2-4%. Companies with larger India-based workforces face higher exposure to these regulatory changes.

With TCS and HCLTech setting the precedent, investor focus now shifts to upcoming results from Infosys, Wipro, and Tech Mahindra, where similar one-time charges cannot be ruled out as companies align employee liabilities with the new labour framework. The regulatory impact represents a one-time adjustment rather than demand-led weakness, with companies maintaining confidence in their operational performance and cash flow generation capabilities.