How the fall in rupee will affect IT companies
BusinessToday.In September 11, 2018
While the rupee's near constant slide against the dollar has sparked off concerns over its macroeconomic position, it has proved to be a boon for export-oriented businesses.
In fact, citing analysts The Economic Times reported that Indian IT services companies could see improvement in margins by as much as 100 basis points in their second quarter results due to the depreciating rupee, based on factors such as their offshoring levels and individual hedging policies. Given that the sector had been facing a lot of headwinds, this comes as a welcome break.
Although the rupee today gained some ground against the greenback from Monday's record low of 72.67, it is still down around 12% in the year so far.
Leading companies such as Infosys, Tata Consultancy Services, HCL Technologies, Wipro, Tech Mahindra and Mindtree each have different hedging policies, which is one of the key factors determining gains from the falling rupee. Usually, domestic IT firms reportedly hedge 30 per cent of their total bills receivable.
"There are multiple aspects and not just the hedging policy. One, for example, is the level of offshoring you have - more offshoring means lower natural hedge and that [in turn] means higher benefit to currency depreciation," Kuldeep Kaul, an analyst at ICICI Securities, told the daily. "Second is margin profile. Let's say TCS has rupee depreciation benefits of 25 basis points. Now their margin is also 25%. This means 1% benefit to absolute EBIT. Whereas if I look at Tech Mahindra, they have 35 basis point sensitivity on 13% margin, so the delta is 2.5 to 3 times, unlike TCS, where the delta is one time."
According to him, although a weaker rupee helps in short-term gains for companies, business fundamentals are the key factor for determining a company's value.
"Infosys, TCS and Mindtree do not have meaningful cash flow hedges and will benefit immediately from INR depreciation," said analysts at the Kotak Institutional Equities (KIE), adding, "LTI, Tech Mahindra and Mphasis are aggressively hedged and will not derive meaningful near-term upside."
The duration of a firm's hedging period also plays a role in determining the extent of forex gain - a longer hedging period does not result in immediate gain from rupee depreciation against the dollar. IT services companies hedge their receivables from projects at a particular currency range for varied durations. According to the daily, Infosys, Mindtree or a TCS hedge for one to two quarters whereas HCL Tech hedges its cash flow for 1-3 years for large chunk of projects.
"Infosys has miniscule cash flow hedges of $300 million...Mindtree hedges only the monetary assets and does not have any cash flow hedges. On the other hand, Tech Mahindra and LTI have hedged 70-90% of net cash inflow over the next 12-months resulting in no change in FY19E EPS [earnings per share]," wrote KIE analysts Kawaljeet Saluja and Sathishkumar S.
According to the Business Standard, Infosys posted a 40 basis points expansion in its operating margin (quarter-on-quarter) to 24.7% in the fourth quarter (Q4) of the last fiscal, aided in part by currency benefits. However, the Bengaluru-headquartered company expects this to be in the range of 22-24% for the current fiscal.
Similarly, TCS, India's largest IT services company, posted an improvement of 20 basis points in its operating margins in sequential basis in Q4. But in FY19, it expects to take it from 25.4% in Q4 to 26-28%.
However, while the broad consensus is that the rupee is unlikely to recover anytime soon - in fact, lenders like DBS Bank Ltd. are now predicting it to weaken to 75 per dollar - the IT sector cannot bet on a lingering currency advantage. "The positive impact of falling rupee would be seen more in near-term than for longer period," said Apurva Prasad, IT analyst at HDFC Securities.