Bengaluru: India’s beaten-down information technology (IT) stocks are rebounding as fears that artificial intelligence (AI) will disrupt traditional tech services ease and investors rotate out of a global tech sell-off, even after a weak September quarter for the sector’s biggest names.
Shares of India’s four of five largest IT services companies rose by as much as 8% on Friday, extending gains even after a muted September quarter. Three of the top four, Tata Consultancy Services Ltd (TCS), HCL Technologies Ltd and Wipro Ltd, posted their weakest September-quarter performance in three years.
The rally came as technology stocks sold off in South Korea, with the Kospi’s 14% decline this week pointing to a shift in global investor positioning. Easing concerns over AI and a rotation in global tech investments appear to be lifting sentiment toward Indian IT, whose valuations had been under pressure since the AI boom stoked disruption fears.
AI stocks have come under pressure in recent days amid concerns that slowing revenue growth, rising infrastructure costs and tighter financing conditions could undermine lofty valuations. The Nasdaq 100 has fallen 3% since Monday. Sentiment also got a lift from finance minister Nirmala Sitharaman’s remarks earlier this week that she was open to views on taxation in capital markets.
“One of the factors may be the finance minister’s comments that foreign portfolio investors may be exempted from capital gains tax. Should this happen, IT stocks may benefit, given their relatively beaten-down valuations, especially if it is accompanied by the unwinding of the AI trade globally,” said Pramod Gubbi, founder of Marcellus Investment Managers.
The Nifty IT index, a guage of India’s software companies surged around 12% this week, while MSCI World Information Technology Index fell 4.5%, according to data compiled by Bloomberg.
IT stocks rebound
Shares of Wipro and Tech Mahindra Ltd rose 6% and 7%, respectively, on Friday, a day after they reported their September-quarter results. TCS and HCLTech, which reported earnings last week, gained nearly 3% and 8%, respectively.
The gains came despite modest revenue growth across the sector. Wipro, the country’s fourth-largest IT services company, reported a sequential revenue decline, while the other three companies recorded growth of no more than 2.1% from the preceding quarter. TCS, HCLTech and Wipro also reported their weakest September-quarter performance in three years.
TCS’s revenue rose 0.2% sequentially to $7.64 billion, while HCLTech and Tech Mahindra each reported growth of about 2% to $3.72 billion and $1.69 billion, respectively. Wipro’s revenue fell 0.1% to $2.61 billion.
Wipro retained its guidance for the December quarter, forecasting constant-currency revenue growth of up to 0.5%. HCLTech retained the upper end of its full-year revenue growth guidance of 4% in constant-currency terms. TCS and Tech Mahindra do not provide quarterly or full-year revenue guidance. Constant-currency growth excludes the impact of exchange-rate fluctuations.
“Expectations were very low for IT. The compression in the legacy business line is not as severe as expected, which is also getting some relief due to inorganic expansions,” said Shubham Dalia, lead IT analyst at Ashika Institutional Equities. “The market is expecting that things might not get worse from here, and thus we are seeing positive momentum. This, coupled with the Kospi sell-off, is pushing Indian IT stocks higher.”
The Kospi sell-off this week also added to pressure on technology shares globally, potentially encouraging investors to reassess their exposure to the AI trade and consider Indian IT services companies whose valuations have already corrected.
AI trade unwind
Another factor supporting the rally could be a reassessment of the assumption that advances in AI would erode the value of traditional IT services companies. Investors are increasingly questioning whether the spending on AI infrastructure will generate returns commensurate with the capital being committed.
“The pace of capital expenditure by the hyperscalers renting out compute to OpenAI and Anthropic is coming under question as monetization through enterprise and consumer AI adoption falls short of expectations, particularly in the context of the expected IPO valuations. Second, as interest rates rise and financing becomes tight, the hurdle rates for the capex go up and become harder to justify. Coupled with question marks on the ability to monetize this capex given slow rates of AI adoption, the AI trade could unwind. IT stocks which got hammered by AI’s rise could benefit from this unwind,” Gubbi said.
Lower valuations and Indian IT companies’ efforts to expand their AI businesses are also contributing to the improvement in sentiment.
Valuations of Indian IT services companies have declined since the launch of ChatGPT in November 2022. According to a Mint analysis of Bloomberg data, the price-to-earnings ratios of TCS, HCLTech and Wipro stood at 13.9, 18.8 and 13, respectively, on 30 September, compared with 30.3, 20.4 and 19.4 at the end of December 2022.
Indian IT services companies are also expanding beyond their traditional businesses. TCS has entered the data centre business, while HCLTech has followed suit and also become the first Indian technology outsourcer to take a stake in an AI firm.
To be sure, not all analysts are convinced that the rally in IT stocks is sustainable.
“We think Accenture’s AI demand is broadening, with growing AI and data partnerships, including in emerging areas such as AI safety, creating new work. However, AI is also delivering productivity gains for clients, and we continue to question its longer-term net impact on IT services growth,” BMO Capital Markets’ Keith Bachman said in a note dated 1 October.
Bank of Baroda Capital Markets analysts Girish Pai and Lopa Notaria struck a more cautious note. “We believe the release of advanced AI models will cause significant disruption to the industry, rendering the sector a value trap’,” they said in a note dated 9 October.
