Currency headwinds may hurt IT companies’ Q4 margin expansion
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Mumbai: Unexpected sharp appreciation of Indian currency may hurt margin expansion of technology companies in a seasonally soft quarter, but the hit is expected to be minimal.
In the fourth quarter of 2017, Indian currency has appreciated 4.74% touching a peak of 64.98 per dollar, the highest since October 2015, while the dollar index is down 1.82%.
Cross-currency headwinds spell bad news for the sector which is already struggling, given the concerns of US protectionist measures after Donald Trump won as President.
According to Credit Suisse, the Indian technology sector is likely to see a moderate cross-currency impact ranging from -40 to 70 basis points (bps). One bps is one-hundredth of a percentage point.
“For the next quarter, there could be over 10 to 40 bps cross-currency impact, given recent strength in euro and Great Britain pound (GBP) against the US dollar. With 0.7% appreciation in rupee (based on the simple average for the quarter), we expect net negative impact of currency on rupee revenue and margins during the quarter,” Credit Suisse said in a report released on 3 April.
It added that sharp negative movement in end-of-period rates of major currencies against the Indian currency may lead to translation losses on net foreign currency-denominated monetary assets. “Hedging gains will depend on the hedged rate and maturity of hedges,” Credit Suisse said.
It has, hence, lowered FY18-19 rupee per dollar exchange rate assumption to 66 from 67, leading to 1-2% cut in earnings across the board, other things remaining constant.
A report from Anand Rathi said cross-currency movements will not significantly bruise earnings, but the dollar-rupee holding at current levels may result in a 5-7% cut in FY18 earnings per share (EPS) at the gross level. “The hedges will offset part of these profit shortfalls in short run,” it added. The brokerage firm sees IT companies reporting weak Q4 with a growth rate ranging from -2.6% to 6.2%. In IT services, growth will be relatively steady ranging from 1% to 2.8%.
According to Motilal Oswal, the recent trend in the rupee may fetch fresh challenge for the industry as currency and lack of growth visibility are likely to keep valuations on edge. “Revenue growth for the industry still remains a challenge, with little, if any, clear signs of acceleration after a tepid 2016. There is hope from deregulation in the US and a new taxation regime, but there remain counterbalancing forces on the other hand, mainly from potential moves on Trump tax and H-1B immigration, recent direction of rupee against dollar might just end up being an additional headwind to thwart any assumptions of sanguine performance around profitability,” it said in a report on 5 April.
Kotak Securities believes cross-currency movements may provide a tailwind of 40-70 bps. “The 1.7% sequential rupee appreciation against US dollar will impact rupee revenue growth and margins. For all the companies in our universe, we expect a 1.3% growth in rupee revenues on quarterly basis. Margins are expected to fall slightly on the back of lower revenue growth and rupee appreciation,” it said in a note released on 10 April.
Kotak added that growth will also be impacted by weak spending in specific verticals and delay in decision making by clients.
Adding to the currency headwind woes, global IT spend is expected to be cut, which will be a major dampener for these companies. Research and advisory firm Gartner said on Monday that the worldwide IT services market is forecast to grow 2.3% in 2017, down from 3.6% growth in 2016. It also said that worldwide IT spending is projected to increase to a total of $3.5 trillion in 2017, lower from the previous estimate of 2.7% increase.
In uncertain times, the management outlook on FY18 guidance is what investors will be eyeing. “Indian IT companies have been sounding optimistic on the potential cyclical recovery in IT spending, particularly in US BFSI. However, this has not translated into any near-term expectation of revenue acceleration. Company managements’ comments on FY18 could be one near-term trigger for the stocks,” Credit Suisse added.
BSE IT index is up 1.86%, while the Sensex and Nifty gained up 11-12% in the Q4 period. In 2017 so far, BSE IT is down 1.18%, while Sensex is up 11.87% and Nifty has risen 12.84%.