However, he cautioned that India’s information technology (IT) companies are staring at an earnings cut, likely to begin in fiscal 2027-2028, amid concerns that artificial intelligence (AI) will compress billings and revenue growth. Edited excerpts:
The Nifty IT Index is down 21% in the last year and has fallen 17% in the last month. How are you viewing the crash in IT stocks across the globe?
There is a clear belief amongst market participants that there will be a reduction in the man-hour effort required for IT services. If you see the current model of IT services, it is a per man hour billing that happens for almost 70% of the projects, now because of AI, if a particular project initially needed 100 hours of work and today that is getting down to say 30 hours, then obviously there is a deflation in terms of the effort that is required and hence lower revenue potential. Whether the equivalent budget will go into newer projects and expand the addressable market to that extent is difficult to predict at this time.
My sense is that there is definitely going to be some slowdown in overall revenue growth for IT companies. If you look at the last four-five years, most of the large-cap Indian IT companies, in dollar terms, have not grown more than high single digits. Comparable US peers in the IT sector have seen a severe de-rating in PE (price to earnings) multiples, thereby capping upside potential for domestic names. Historically, we have seen that when growth visibility declines, PE multiples take a hit.
Do you expect the bearish sentiments in IT to sustain, or are you expecting some upside movement in the future?
The multiples (for IT companies) will probably shift 10-15% down as compared to historical levels, so what used to be a 20-22 multiple will now shift more towards the 17-20 band, given the fact that people are now more concerned about what sort of impact AI will have on revenue growth. IT companies will settle in a lower P/E range, and depending on how earnings pan out, the market will take a call. My sense is that a structural PE-multiple de-rating is underway across most IT names.
A large part of the de-rating is already underway. Earnings cut will start happening more towards the end of FY27-FY28 in my view.
India does not have many AI companies listed in the public markets. Do you think the country and its stock market will lose out to peers due to this?
The rally in most of the other markets, like Korea or US, was concentrated in AI stocks, and because our indices do not have AI stock participation, we suffered. We saw outflows of close to $30 billion last year, and even in January-February, we are seeing the same continuing. We expect nominal GDP (gross domestic product) growth to settle at close to 9-10% for the foreseeable future, and if we take 2-3% rupee depreciation, FIIs (foreign institutional investors) are looking at 6-7% return in dollar terms, which doesn’t seem very lucrative and explains the FII outflows for the past few years.
Unless the growth trajectory accelerates substantially, I do not think FII flows will come back in a large way. However, the pace of selling should definitely slow, providing some relief.
Mid-and-small-cap stocks were an investor favorite for a few years. Now, they seem to be running out of favour. Do you think the rally in mid- and small-cap stocks is over?
About 18 months ago, the NSE (National Stock Exchange) mid-cap index was trading at almost a 27% premium to the Nifty 50, which has rarely been the case in the last 15-20 years. Now, because of challenging macros, be it the tariff issue or slowing government spending, earnings growth for mid-caps has slowed down.
Textiles and chemicals went completely out of favor due to tariff-related issues. In the case of EPC (engineering, procurement and construction) companies, execution slowed down due to working capital strain. So the correction in mid-cap stocks is driven by slowing earnings growth.
From here on, if you have to see the rally coming back, we have to start seeing earnings revive and government spending return. I think once trade flows with the US resume, sectors such as textiles and chemicals should revive.
The recent correction has taken froth away in a lot of midcap names, and things should start stabilizing hereon.
It is very difficult to generalize the small-cap space as a whole. Because in a lot of stocks, prices have gone far beyond fundamentals. You just couldn’t justify seeing the numbers as to what the stock was building in at that time. Because there was very high liquidity chasing a small flow. I think that euphoria has gone away.
Which are some sectors where you’re seeing really good potential for a rally and where retail investors can focus for now?
Banking is clearly one of the sectors we are very positive about. We are more or less done with the rate cuts for this cycle. If loan growth itself is going to be 12-13%, operating profit growth could be closer to 15% given the fact that NIMs (net income margins) will start improving from here. Valuations for most banking stocks are below 2x price-to-book on FY28e earnings. Given valuation support, the incremental downside is very minimal for most banking names.
Telecom is also something that we like. There’s almost a 70-75% flow through to EBITDA (earnings before interest, taxes, depreciation and amortization) of the tariff hikes, because a lot of operating costs are fixed in nature. The sector is also unaffected by most geopolitical issues.
And thirdly, given that cement has become an oligopolistic market, at some point in the next 12-18 months, my sense is that the two players will look to take the pricing higher, and the overall profitability of the sector should improve.
For a while, we saw both Nifty and Sensex within a range and were shying away from their peaks. Are you seeing a similar oscillation in the next 12 months, or do you think there is a possibility of breaching the peak?
We feel there will be new highs in the next six months because on an FY28 basis, we are today at close to just 18 times earnings. Historically, except for covid and the global financial crisis, we have rarely traded below 17 times one year forward earnings, and the median multiple is 20 times.
We are now one standard deviation below the median multiples due to relentless FII selling. My sense is that once selling slows, we should head towards the 28,000 level over the next 12-15 months.
