The massive sell-off in emerging market equities has once again focused attention on the carry trade. The unwinding of these trades can be seen from the strengthening of the Japanese yen, which reached an eight-month high at 115.13 against the dollar on Thursday, and continues to gain.
The last time the yen strengthened to this extent was immediately after the stock market scare in February/March. At that time, the yen had fallen from slightly more than 121 to the dollar to around 115, before rebounding to 118 or thereabouts by the end of March.
This time, too, the yen was at around 120 to the dollar on 25 July, just before the decline, so the fall hasn’t really been catastrophic so far.
The carry trade had also been invoked during the sell-off in the equities markets in May last year, when the yen strengthened from around 118 to the dollar in the middle of April to a low of 109.37 on 17 May. That’s a far bigger move than has occurred so far during the current panic. Of course, none of these episodes resembled the 1998 collapse of hedge fund Long Term Capital Management, when the yen rallied by 20% in two months. Between late August 1998 and late September that year, the yen rallied by 9% against the dollar, from 147 to 134. Then, between 5 October and 8 October, the yen gained 12%. But, while global markets were selling off between August and September, the sharp yen appreciation in October did not really have much of an impact.
In short, risk aversion is the reason for the unwinding of carry trades which, in turn, leads to falls in high-yield currencies and emerging markets.
Once the panic subsides, the carry trade will resume—with rates so low in Japan, and with the latest data showing growth in that country faltering, there are compelling reasons for the carry trade to continue.
But before that happens, banks will have to find the courage to lend once again.
HCL Technologies Ltd shares have outperformed the NSE’s CNX IT index handsomely since April.
With a gigantic $900 million (nearly Rs3,700 crore) in forex hedges, HCL Technologies’ foreign currency inflows were hedged for more than a year, and hence it was evident that it would fare far better than any of its peers in managing the impact of the appreciating rupee. The 7% appreciation in the rupee led to a forex gain of $61.5 million last quarter. As a result, net profit jumped 46.7% sequentially to Rs 486.7 crore, despite a 7.6% drop in operating profit. For the year till June, net profit jumped by 75.1% to Rs1,355 crore—the highest increase among the top five players in India—again buoyed by an unusually high forex gain of Rs328 crore.
That’s not to say that the company’s operating performance wasn’t good. On the contrary, the company reported its best performance in recent years. Revenues grew 42.4% to $1.39 billion, among the highest in the $1 billion club.
Also, this was much better than the 28% growth the company managed in the year till June 2006. What’s more, operating profit margin was maintained at 18% as the company’s “transformation journey” bore fruit.
This is commendable since the industry saw a year-on-year dip in margins in the July 2006-June 2007 period, with salary increases and the appreciating rupee eating into profits.
Analysts are also happy with the fact that HCL Technologies’ performance has become more consistent—its revenues have now grown by more than 9% sequentially in each of the last four quarters.
The company’s infrastructure services business is doing exceptionally well, growing revenues by 75% in dollar terms and earnings by as much as 144%. This division now accounts for more than 14% of revenues.
A related worry, however, is that this fast growing business has much lower margins (11%) compared with the company average of 18%. While this may lead to a drop in overall margins, growth in absolute profit would not be affected.
Another factor that’s troubling some analysts is the large amount of outstanding stock options. If all of them were converted, the company’s equity will be diluted by more than 7% and so would its earnings per share.
But, even after adjusting for that, HCL Technologies shares trade at a significant discount to all of its peers in the $1 billion club. The company would need to maintain consistent growth to enjoy valuations as high as some of its peers.
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