Bangalore: Facing shrinking orders from US, their top market, Indian information technology (IT) outsourcers cannot rely on a weakening rupee to subsidize earnings and lift share prices out of the doldrums in the long run.
The rupee’s strength against the dollar has long been the bane of information technology companies, such as Infosys Technologies Ltd, since the bulk of sales are made in dollars but their expenses are incurred in rupees, squeezing their margins.
The rupee’s 8% drop against the dollar this year has given shares in Infosys, India’s No. 2 outsourcer, and its rivals a temporary reprieve, but analysts argue that its weakness is not enough to provide lasting relief in the face of a US economic slowdown.
With an army of English-speaking workers and relatively cheap wages, technology exporters such as Infosys and Tata Consultancy Services Ltd (TCS) have thrived on winning deals from overseas clients — the majority of which are in the US.
The party ended last year when Wall Street banks, some of whom are Indian IT companies’ major clients, began to announce staggering write-downs related to the subprime mortgage crisis, and the wider US economy headed towards recession.
India’s software and back-office services firms will see a slower revenue growth of 25% in the current fiscal year to March, down from an estimated 29% in 2006-07 and more than 30% in previous years, according to lobby group National Association of Software and Service Companies (Nasscom).
“We feel that there is still pain left to be seen in the sector and expect more headwinds to make headlines,” Sanjeev Hota of Reliance Money Ltd, which has a “hold” rating on all the top four IT services companies, wrote in a research report. The big four Indian software firms missed market estimates for net profits in the last quarter and issued cautious outlooks.
Profits had soared in the past, as increasing numbers of US companies looking to cut costs and boost efficiency placed orders, while a weak rupee boosted margins.
In 2007 the sector index on the Bombay Stock Exchange fell 14% against the wider benchmark 30-share Sensex that rose more than 47%, as the rupee surged more than 12% against the dollar towards 10-year highs and fears of a US recession emerged.
In the short term, the weaker rupee has boosted outsourcers margins. The leading outsourcers earn more than half their revenue in the US, and analysts say every 1% rise or drop in the rupee impacts the profit margins of Indian software services firms by 30 to 50 basis points.
A basis point is one hundredth of a percentage point
“Currency has been a major headwind for the performance of IT companies,” Motilal Oswal Securities Ltd said in a report. “Now, with the rupee reversing its appreciating trend and depreciating, we believe one critical headwind has weakened.”
The rupee was trading at around 42.82 a dollar on Thursday, well below last year’s close of 39.41.
It ended Thursday at 42.84 to the dollar. JPMorgan sees the rupee weakening to 45 per dollar, with risks for an even sharper fall, by the end of 2008.
Motilal increased its earnings per share (EPS) target for New York-listed Infosys, which has a market value of about $27 billion, by around 3% to Rs97.30. Motilal also raised its EPS targets for TCS, third-ranked Wipro Technologies, and No. 4 Satyam Computer Services Ltd by between 1.5% and 6.5%.
“The recent rally in Indian IT stocks has been led by the sharp depreciation in the rupee,” Manik Taneja, sector analyst with Emkay Share and Stock Brokers, wrote in a report. “However, despite the early cheer from the currency benefit, it is imperative for investors to refocus attention on the macro demand environment front, as they are bigger driving factors for financials of the companies.”