Value buying

Investors are betting on the transformation of Indian IT

The Nifty Information-Technology (IT) Index last week hit a 10-month high. The sector index is up over 11 per cent in the past one month, in contrast to the benchmark Nifty 50, which is down 3.6 per cent. One reason is that the first-half results of IT companies have met expectations, and future demand is judged stable, going by admittedly cautious guidance. Another reason for the rally is low valuations. The sector’s average valuations are down to levels that have not been seen since the subprime crisis of 2008. Low PE (price-to-earnings) multiples are attracting value investors, who are betting on valuation rebounds. Going by guidance, demand will not spike. But stable demand should translate into steady, if moderate, growth in constant-currency terms. Given a trend of rupee weakness, the returns may be higher and provide a hedge against currency volatility. 

Such cyclical considerations, the key questions for long-term investors, revolve around the Indian IT sector’s ability to leverage the structural changes imposed by artificial intelligence (AI). Trends in software and IT services have decoupled. The AI productivity gains that are expanding software’s pricing potential are also compressing billable hours for services. Enterprises are rejigging budgets to invest in cloud infrastructure and AI-enabled platforms, as evidenced by hyperscaler growth. In the past two years, this divergence has led to a relative de-rating of IT services. But there are signs that India’s IT sector has learnt how to survive and, maybe, thrive, under this new paradigm. Tata Consultancy Services (TCS), HCL Tech, Infosys, Tech Mahindra and others have all increased their internal productivity metrics via AI and have started rolling out AI-driven offers for clients. Their management has highlighted opportunities emerging across AI. 

Often in partnership with AI-specific players such as OpenAI and Anthropic, Indian IT majors are finding ways to create niches in an ecosystem where every enterprise is looking at AI. Infosys, for example, is helping the banking and financial sector to accelerate AI-driven transformation, using its Topaz offers. HCL Tech has its five-pillar AI strategy and offers like AI Force and HCLTech Pulse. Tech Mahindra has its Zero Gravity Architecture, which helps enterprises prepare for AI deployment. TCS says its AI-revenues contribute over 10 per cent of its top line on an annualised basis. It is also developing a presence in data centres.

The amount of demand (in terms of client budgets) is largely unchanged, though the attention has shifted to AI. Spending by the banking, financial services, and insurance (BFSI) sector is concentrated on core modernisation, cloud, data and AI, while technology clients are investing in physical AI. Management commentary indicates that pricing deflation for services may be close to an inflection, since contracts have already undergone repricing over the past two years. One advantage with AI adoption is that the total contract value is realised in shorter timeframes, allowing quicker recognition of revenues and fast pivots in resource deployment. Assuming IT-services firms can partner AI companies to deliver speed, efficiency, and productivity benefits, they could move past the old model of labour arbitrage. Investors buying into IT services during this valuation nadir are betting on this transformation.