Lack of AI Is Reducing India Software Stocks’ Heft as Tech Bets

Shares of India’s vaunted IT outsourcing firms are facing a reality check, as global investors’ rush into the artificial intelligence theme starts to leave pricey old-economy tech stocks behind.

Lack of AI Is Reducing India Software Stocks’ Heft as Tech Bets

Shares of India's vaunted IT outsourcing firms are facing a reality check, as global investors' rush into the artificial intelligence theme starts to leave pricey old-economy tech stocks behind.

Unlike counterparts in the developed world and China, Indian software makers including leader Tata Consultancy Services Ltd. have yet to make significant advances in generative AI. That combined with a still cloudy outlook for client spending may soon leave them looking like the tech bets of yesterday.

“Traditional software companies' earnings and valuations are at risk because their business models are not evolving with the times,” said Deven Choksey, managing director of DRChoksey FinServ Pvt.

A BSE Ltd. gauge of Indian software stocks has recently fallen through key support levels into a technical correction. Yet it's still trading well above its historical average earnings multiple after a yearslong rally in the nation's equity market.

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India's IT firms enjoyed years of strong growth as the world's biggest corporations outsourced a vast amount of back-office work to save money, in a phenomenon known as getting “Bengalurud”. Those revenues have been slowing more recently as overseas customers cut spending to cope with challenging economies.

Meanwhile software and internet majors such as Microsoft Corp. and Alphabet Inc. have been investing billions to develop their own cloud offerings and large language models.

“Coding is getting left behind by computing in the tech investing world,” said Choksey. Indian firms need to reinvent their business models more quickly to embrace AI and deliver better software-as-a-service solutions and infrastructure like Amazon.com Inc.'s unit Amazon Web Services does, he added.

TCS last month reported its slowest annual sales growth in three years. Competitor Infosys Ltd. issued a tepid forecast for revenue growth of 1% to 3% in the year through March 2025 on a constant-currency basis, eliminating the the impact of exchange-rate fluctuations.

While the Indian companies and peers around the world like Accenture Plc are making positive noises on AI, the sales contributions are still small. TCS said its AI pipeline doubled last quarter to $900 million — that compares with its total annual revenue of around $30 billion.

The volatile geopolitical environment and uncertain macro outlook continue to weigh on client spending priorities. The IT sector may see further downgrades after sales missed expectations last quarter, according to Jefferies Financial Group Inc.

“Results by IT firms disappointed on the top line, and management commentary points to a weaker-than-expected growth outlook,” analysts Akshat Agarwal and Ankur Pant wrote in a note dated May 7. “Despite up to 7% cuts to consensus estimates last month, we see further risks to earnings, limiting upside” in share prices.

Lofty valuations also point to caution. The BSE tech gauge is trading at 24 times forward estimated earnings, compared with pre-pandemic levels of about 18 times. That comes as metrics of growth in sales and earnings have dropped below levels enjoyed by the sector in 2019.

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India's software makers have been seen as laggards in artificial intelligence. In the absence of substantial advances in this area, they may lose investor interest as their business faces threats of cannibalization.

“The theme of corporations spending more on AI while cutting back on non-AI spending is global in nature,” said Anurag Rana, an analyst at Bloomberg Intelligence. “We are seeing no signs of a rebound.”

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