Shares of Voltas Ltd lost 2.8% though the broad markets rose on Friday. The markets were evidently not happy about the company’s March quarter results, which were released after the markets closed on Thursday. The company’s mainstay electro-mechanical projects and services business, which accounted for about 54% of revenues last fiscal year, reported a mere 2.4% increase in operating profit last quarter. In the preceding three quarters, the segment’s profit had grown by as much as 71.5%.
The company explained in a conference call with analysts on Friday that some large projects booked in fiscal 2007 were completed in last fiscal year and this boosted revenues and profit in the first few quarters. But the opposite happened in the March quarter, where the company wasn’t able to achieve milestone levels in five large projects, cumulatively worth Rs1,500 crore. The company books profit margins only after it completes 10% of the work on a project.
According to the company, the segment’s profit would have risen by about 20% last quarter if the profit margin for the completed works were considered. Its above explanation fits with the jump in its order book position last quarter. At the end of December 2007, the electro-mechanical projects and services segment had an order book of Rs3,500 crore. This has risen to Rs4,631 crore, or nearly three times the segment’s annual revenues of Rs1,641 crore. According to an analyst, since most projects have a short completion time frame (less than two years), the ‘execution risk’ that is inherent in some engineering companies is rather low for Voltas.
What’s more, more than 80% of the orders pertain to international markets, and hence the slowdown in the Indian markets is less of a worry. The company’s cooling/air conditioning business continues to grow at a strong pace of about 37%. Higher volumes and the sharp appreciation in the rupee helped the division increase its annual profit by as much as 448%. This segment gains from an appreciation in the rupee because of a high level of imports.
The company’s shares, meanwhile, have corrected sharply and are now just 3% away from the lows of Rs158 they hit in late March. At its peak of about Rs262, the stock traded at as much as 44 times trailing earnings. It now trades at about 27 times trailing earnings and that seems reasonable, considering earnings are expected to grow by an average of about 30% for the next two years.
IT stocks: don’t forget the hedges
Software stocks have risen smartly since the rupee breached the 40 mark on 23 April and started depreciating gradually since. The CNX IT index has risen by 12.3% since, while the markets have been flat. Some of the gains were on account of the one-year extension of the tax holiday for software parks. But a majority of the gains are on account of the sharp depreciation in the rupee.
The rupee has fallen nearly 7% during the period and each percentage drop results in an increase of about 1.5% in operating profit. Analysts’ estimates and company guidance targets are based on an exchange rate of 38-40 per dollar, and if the domestic currency remains at current levels of 42.5, earnings growth could be significantly higher than expected.
But the improvement in operational performance is just one part of the story. Until recently, the rupee was moving in the opposite direction, and most companies increased their hedges substantially. Tata Consultancy Services Ltd (TCS), Wipro Ltd and HCL Technologies Ltd (HCL) had hedges of approximately $3 billion (Rs12,780 crore today) each at the end of March.
Infosys Technologies Ltd has cut its hedge positions and has only about $750 million in hedges. These positions will face losses if the rupee remains at the current levels or weakens further.
Put simply, firms with large hedge positions, taken at an exchange rate of 40-41, will effectively realize their revenues at exactly that rate.
They won’t benefit from the depreciation in the rupee, to the extent that future revenues are hedged by shorting dollars in the derivatives market.
Not all firms with a high amount of hedging positions will report major losses. TCS, for instance, mainly uses options and its downside is limited since it will just have to forego the option premium paid. But HCL, on the other hand, has a large amount of forward contracts outstanding and will be hit.
Surprisingly, shares of Wipro, which has the largest amount of hedges ($3.5 billion), have gained the most (18.4%) since 23 April.
It’s also interesting that TCS shares have risen the least (10.6%) despite having more than 90% of its hedge positions in options, where the downside is limited. The concerns about the company’s disappointing March quarter results seem to be still lingering on the market’s mind.
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