Gaining From The Rupee Fall

The depreciating rupee might provide fresh opportunities to invest in stocks
Tanvi Varma/Money Today        Print Edition: August 2013

The gloom surrounding the recent rupee fall has been unnerving for investors. The near 11% fall in the currency between January and July is hurting large parts of India Inc. For stock investors, the rupee's roller-coaster ride over the last few weeks has added another layer of uncertainty in a market whose movements over the last few months have anyway been as unpredictable as during any time in recent history.

Experts predict that the rupee may slip further in the days to come. What does that mean for your portfolio? Is there some way you can gain if that happens?

Definitely, you can, if you tweak your portfolio to include stocks in the sectors that might gain from the rupee's fall. These include pharmaceutical and information technology that earn a big part of their revenues in dollars. Every dollar earned through exports means more rupees added to the bottom line.

However, let's first tell you why rupee fall is considered bad news.

At a basic level, rupee weakness signals that investors are losing faith in India and exiting their investments here in the belief that their money can earn better returns elsewhere.


This is exactly what happened last month, when the dollar rose after the US central bank, the Federal Reserve, or Fed, hinted at economic recovery in the US and said it might reduce the amount of dollars being injected into the system to support growth.

Foreign investors, already nervous about India's high current account deficit, or CAD, fell for the rising dollar bond yields as a result of the Fed's actions and took money out of India to invest there.

As US 10-year Treasury yield rose from 2.1% to 2.5% within a month, "inflation-adjusted returns in developed markets started looking more attractive," says Tushar Pradhan, chief investment officer, HSBC Global Asset Management.

This triggered the largest-ever monthly redemption by foreign institutional investors, or FIIs, from the debt markets in June, when they took out $5.4 billion.


The currencies of most emerging markets, especially those with large CADs, fell 5-10% against the dollar during the period, says Pankaj Pandey, head of research, ICICI Securities.

But why was the rupee fall so steep?

The reason, say experts, is that foreign investors were already edgy about India's finances, especially the large CAD, and took flight at the slightest hint of better opportunity abroad. Pradeep Gupta, vice chairman, Anand Rathi Financial Services, says countries with huge deficits are usually the worst off in currency sell-offs.

For stock investors, rupee is a key factor to watch out for. A weakening rupee hits India's markets, which are highly sensitive to FII flows. The reason for this is simple. FIIs hold 24% of BSE-500 companies, and any fall in the rupee lowers their returns (they earn less in dollar terms). This leads them to the exit door and weakens the rupee further as they sell their India investments and exchange rupees for dollars to invest somewhere else.


Now, let's look at sectors and companies that will gain/lose from the current trends in the currency market.

IT SECTOR

IT companies earn most of their revenues in dollars. So, each dollar earned abroad will now get them more rupees. Pandey of ICICI Securities expects IT companies to post higher revenue growth this year. He expects the average realised rate for the first quarter of 2013-14 to be 55.82 as against 54.17 in the fourth quarter of 2012-13. An industry thumb rule says that every 100 basis points, or bps, rupee movement impacts operating margins of IT companies by 30-50 bps.

However, IT companies may not gain much in the first quarter of 2013-14 as the steepest rupee fall was in June, the last month of the quarter. "If the rupee stays at its current levels for a large part of the September quarter, the average depreciation may be higher. This could help revenues and margins in the coming quarters," says Pandey.

Though the rupee is coming to the rescue of IT companies, it does not mean that everything is hunkydory for the sector. "Although the IT sector will be better off than the others due to the rupee fall, the usual thesis may not work this time due to stiff competition between middle-level and large companies. Customers, too, will ask for discounts," says P Phani Sekhar, fund manager, portfolio management service, Angel Broking. "The customers know that the rupee depreciation will continue for some time and, hence, will not let IT companies enjoy the windfall alone," he says.

Prateek Agrawal, chief investment officer, ASK Investment Managers, says rupee fall does little to increase the demand for India's IT exports. A sharp rise in exports happens only when there is huge spare capacity which, he says, India does not have at present.

Top Picks

Infosys: Recommended by ICICI Securities

>> The company does not have foreign currency debt.
>> Foreign earnings were 52% of total in 2012-13
>> Rupee fall helped dollar revenues grow 2.7% sequentially in the first quarter of 2013-14. Rupee fall pushed up operating profit margins by 120 bps

TCS: Recommended by Barclays

>> Revenue rose 4.8% sequentially led by a healthy 6.1% quarter-on-quarter volume growth.
>> Growth seen across verticals and service lines with the order backlog at the end of the quarter providing good revenue visibility for the remaining quarters.

PHARMACEUTICAL SECTOR

ASK's Agrawal expects big gains for the sector as exports account for 50% sales of most big pharmaceutical companies. However, the recent rupee fall may not yield immediate gains. "Most exporters have hedged their currency exposure for the next six-nine months at a lower rate," says Pandey of ICICI Securities. Also, if one looks at the 90-day average for the first quarter of 2013-14, the rupee is down just 3% vis-à-vis the average rate in the fourth quarter of 2012-13. Big gains are likely to flow from the second half of 2013-14 if the rupee remains at the current level.

Top Picks

Divi's Labs: Recommended by ICICI Securities, Motilal Oswal

>> The company has no foreign exchange debt and has not hedged future revenues. Its net foreign exchange exposure is 70% of revenue. Rupee fall will add to sales and margins as Divi's is a net exporter.

Sun Pharma: Recommended by ICICI Securities, Emkay

>> The company does not have foreign exchange debt and has not hedged future revenues. Net foreign exchange exposure is 50-55% of revenue. Falling rupee will add to sales and margins as it is a net exporter.

Dr Reddy's: Recommended by Emkay, Anand Rathi

>> The US business, which accounts for 50% formulations revenue, is the key profitability driver. It is expected to grow at 20% a year between 2012-13 and 2014-15.
>> Operating margin to improve on the back of strong growth in the US, better currency realisation and large unhedged exports. Average dollar realisation is less than Rs 50, and is expected to be 56 next year, a rise of 12%.

OIL AND GAS SECTOR

Experts expect a mixed impact on the sector. "A falling rupee is usually negative for importers, for instance, companies that buy petroleum products abroad," says Pradhan of HSBC.

The worst-hit will be government oil marketing companies such as HPCL and BPCL. This is because of limited ability to pass on higher crude oil (which they import) prices to consumers due to price controls (except on petrol). The actual impact will depend upon the extent of increase in diesel prices and how much they are compensated by the government for selling fuels below the production cost.

Angel Broking's Sekhar says the Centre has budgeted Rs 80,000 crore for subsidy-sharing this financial year. However, with the rupee trading around Rs 59, this will rise to Rs 1,20,000 crore. "Further, the subsidy-sharing formula will be decided in May 2014 only," he says. Under the formula, the government, upstream oil companies such as ONGC as well as oil marketing companies share the fuel-subsidy burden. In general, for every Re 1 fall in the value of the rupee, under-recoveries, or losses, of oil marketing companies rise by Rs 6,600 crore. Experts say the cost of servicing foreign currency loans will also rise.

Pandey of ICICI says the impact on ONGC will be minimal as its overseas subsidiary, OVL, which earns in dollars, accounts for 10.8% consolidated revenue.

A CRISIL report says the impact of higher fuel prices will also be felt on the demand for automobiles. Fuel accounts for 25-30% ownership cost of a small car in the year it is bought.

Airlines, which earn a big part of revenue from domestic operations, will also be hurt by the rupee fall, as 70% of their operating costs are incurred in dollars. Plus, their ability to pass on higher costs to consumers is limited due to stiff competition in the sector.

Top Picks:

Reliance Industries: Recommended by Motilal Oswal

>> Crude oil producers and pureplay refiners will gain as their prices, denominated in dollars, are determined by global demand-supply dynamics. In fact, exports account for 60% of RIL's turnover. According to Motilal Oswal, every 1% fall in the rupee increases RIL's earning per share by 1.2%. However, some of this benefit may be offset by higher outgo on foreign currency debt of Rs 70,000 crore.

Cairn India: Recommended by ICICI Securities, Motilal Oswal

>> Since Cairn earns in dollars, a falling rupee will increase revenues & profits. The company has high dollar reserves and so will report foreign exchange gains in the current quarter. ICICI Securities says the target price of Cairn India rises by Rs 8 per share for every Re 1 fall in the value of the Indian currency against the dollar.

POWER AND METALS

Companies with huge dependence upon imports will be hit by a rise in the cost of inputs. "Power companies will be impacted as the price of coal that they import is linked to international prices," says Gupta of Anand Rathi. Further, a large number of power companies have borrowed heavily in dollars. For example, Tata Power's foreign debt of Rs 13,500 crore (39% of total) will most likely rise by Rs 675 crore because of the falling rupee. The Adani Group, too, has foreign currency loans amounting to Rs 4,000 crore.

However, metal companies will gain, as they pay import-parity prices for coal. But experts warn that some metal companies may be hit by unhedged foreign currency liabilities. Pandey of ICICI says profitability of Tata Steel's India operations is likely to rise as the company pays import-parity prices for coal.

However, experts say the company will be hit by unhedged foreign currency convertible bonds, or FCCBs, amounting to $547 million (Rs 3,000 crore, out of total standalone debt of Rs 27,500 crore) and is likely to book a mark-to-market foreign exchange loss in its profit and loss account.

Experts are more positive on Hindalco. The company, they say, will benefit from the rupee fall as its realisations are import paritylinked while alumina requirements of its Indian operations are met from domestic sources. However, it is likely to book a foreign exchange loss on account of unhedged foreign currency loans. At the end of 2012, Hindalco had foreign currencydenominated loans of Rs 27,000 crore, 60% of its total debt.


AUTOMOBILES

The falling rupee has increased the cost of imported inputs on which the industry depends a lot. For instance, Maruti Suzuki imports about 20% components from Japan.

Further, a number of auto companies have taken foreign currency loans in the form of external commercial borrowings and FCCBs. For example, Motherson Sumi, a components maker, has a Rs 3,120 crore loan on its balance sheet. It reported a foreign exchange loss of Rs 64 crore in the third quarter of 2012-13.

Tata Motors, too, has foreign currency loans of Rs 3,400 crore. However, one saving grace for the company is that it earns around 70% revenue from outside India. Like Tata Motors, there are a number of companies for whom exports are a big source of revenue. Bajaj Auto's margins, for instance, are expected to rise 70 bps quarter-onquarter to 18.5%, due to higher realisation from exports, which account for 35% revenue.

The major impact of the rupee fall is likely to be felt by companies that have raised money through FCCBs. Mukesh Agarwal, president, CRISIL Research, says 40% debt of companies in the CNX Nifty index (excluding banking and financial services) is in foreign currency. India Inc had foreign exchange debt of over $200 billion as on March 2013, of which close to 45% was short-term debt. Only half this exposure is hedged.

One of the most indebted sectors is telecom.

For instance, Bharti Airtel and Reliance Communication have foreign debts of Rs 48,000 crore and Rs 27,000 crore, respectively. These loans were taken mainly for speeding up expansion, in Bharti's case the purchase of Zain Telecom in Africa. Though the Indian currency's fall will boost the revenue and operating profit of Bharti's African operations, it will also increase the company's net loss. Based on an analysis, an 8.3% rise in the dollar will impact Bharti's profit before tax by Rs 500 crore. For Reliance Communication, the foreign currency debt of Rs 27,000 crore accounts for 70% of the total. It is likely to rise by Rs 1,500 crore considering the 8% rupee fall.

INDIRECT IMPACT

Some companies will be indirectly hit by the rupee fall. To start with, the fall will slow economic growth as foreign funds lose confidence in India and take their capital elsewhere. This will compress margins and make it difficult for companies to pay off debts, in turn putting pressure on banks as well.

The trend has also postponed the likelihood of a cut in interest rates. This is because a rate cut will further devalue the rupee. A report by IndiaNivesh has predicted that the number of accounts going for corporate debt restructuring will rise 50% year-on-year to Rs 30,000 crore in the first quarter of 2013-14.

According to Gupta of Anand Rathi, the impact of rupee fall on infrastructure and capital goods companies is relatively low as their contracts provide for cost escalation due to currency movements.

GOING FORWARD

According to Gupta, the rupee could bounce back in next two-three months due to government measures and improvement in the CAD.

Prasad Koparkar, senior director, CRISIL Research, says demand growth and competitiveness, rather than currency movements, determine growth and profitability. The view is corroborated by the modest performance of export-oriented industries in 2012-13, when the rupee fell 14% against the dollar.

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