AI relief fails to lift legacy IT stocks as earnings worries weigh

Mumbai: Has Indian IT turned the corner?

After surging more than 17% in October, the Nifty IT index appears to have lost momentum, declining nearly 2% so far in November, although the Sensex and Nifty harnessed new-found enthusiasm from foreign funds to climb more than 10% in the run-up to Diwali and its immediate aftermath.

Legacy IT stocks have stagnated despite a precipitous plunge in AI-heavy bets across Asia, putting a question mark over whether earnings concerns at outsourcing firms would continue to keep prices - and valuation multiples - in restraint despite obvious opportunities arising from a sectoral churn.

Since the beginning of October, South Korea's Kospi and Taiwan's stock index have fallen around 20% and 13%, respectively. Japan's Nikkei has declined 10%, while the Nasdaq Composite has lost 6%. The Shanghai Composite and Hang Seng have fallen 4.4% and 2.4%, respectively, reflecting the correction in global AI-related stocks.

The September-quarter earnings of Indian IT companies, meanwhile, point to an uneven recovery, with mid-tier players outperforming larger peers while underlying demand conditions remain largely unchanged. Choice Institutional Equities said companies under its coverage reported average sequential revenue growth of around 5.4% for tier-2 players, compared with nearly 1.1% for tier-1 companies.

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Coforge led the mid-tier pack with 10.9% growth, followed by Persistent Systems at 7.8%, while Tech Mahindra and HCLTech led among larger companies.

However, healthy deal bookings have yet to translate into commensurate revenue growth. Phased transitions, staggered project ramp-ups and longer client decision-making cycles continue to delay revenue conversion.

Shorter-cycle AI engagements, typically lasting one to two quarters, are also limiting the visibility traditionally associated with large, multi-year deals, Choice said.

A key concern for the sector is the changing economics of technology services as clients increasingly use AI to improve productivity and reduce costs. While AI is creating new business opportunities, these gains are yet to fully offset pricing pressure in traditional services.

Kotak Institutional Equities estimates gross deflation of around 7% and net deflation of 3.5% for companies as clients seek a greater share of productivity savings through contract renewals.

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Sandeep Gogia, MD and co-head, Investment Banking, Equirus Capital, said pressure on enterprise clients to improve returns on AI-related investments, alongside concerns around safety, security and token-cost optimisation, could create fresh opportunities for IT services providers. "Integration of systems of records and data systems with systems of intelligence and AI models is not plug and play," Gogia said, pointing to opportunities in data engineering, application modernisation, cloud migration and cybersecurity as enterprises move towards large-scale AI implementation.

On profitability, Choice said operational efficiency and cost discipline had partly offset wage and delivery-related pressures, although margin performance remained mixed. Kotak expects margins at large IT companies to remain largely stable, with rupee depreciation providing some support. However, pricing pressure and AI-related investments could weigh on profitability.

The earnings outlook also remains uneven. Kotak expects Infosys to lower its FY27 revenue growth guidance to 1.5-2.5%.