BackRupee depreciation provides respite for Indian IT amid margin pressures
The Indian rupee has depreciated considerably against the US dollar so far this quarterWith IT companies earning a large part of their revenues from the US, this will aid their margins
PremiumMUMBAI : Earnings upgrades ahead of quarterly results are not commonplace, especially for the Indian IT sector, whose profitability is under pressure and is facing questions about sustainability of the pickup in revenue growth rates.
Still, thanks to rupee depreciation, earnings estimates are seeing upward revisions, though only marginally. So far this quarter (as on 16 September), the Indian rupee depreciated 1.4% against the dollar compared to the average exchange rate in April-June this year.
Tracking the softness and benign outlook for Indian rupee, Kotak Institutional Equities raised its earnings estimates for IT companies under its coverage by up to 4%.
“We bake in Kotak economist’s revised INR/USD rates of 71-74 from 70-72 earlier for FY2020-22E. Revised INR/USD estimates and cross-currency headwinds to revenue growth effectively result in 10-50 bps increase in Ebit margin assumptions and 0-4% increase in EPS estimates for FY2020-22E for various companies," analysts at Kotak Institutional Equities said in a note.
Rupee depreciation aids profit margins. A 1% depreciation in the local currency against the greenback aids IT companies’ earnings before interest and tax (Ebit) margin by 20-30 basis points (bps), points out the note from Kotak. 100 basis points equal one percentage point.
Of course the extent of benefits from the weakness in the local currency depends on the level of hedges. Tech Mahindra Ltd and L&T Infotech Ltd are said to have hedged a large part of their cash flows and are expected to see minuscule benefits. TCS Ltd, Infosys Ltd and Mindtree Ltd on the other hand are estimated to see noticeable impact.
The benefits from currency depreciation, however, can be temporary at best. In a competitive business environment it is difficult to hold on to the currency gains beyond a couple of quarters.
As a study by analysts at Motilal Oswal Financial Services Ltd shows, a sharp depreciation in the rupee notwithstanding, gross margins of large Indian IT companies have steadily dropped over the last five fiscal years.
As contracts are renewed, companies tend to pass on the benefits from currency depreciation to clients. This puts the onus of earnings growth on the demand environment, which is not in the best of health.
Sluggish economy and low interest rates are crimping earnings outlook of banking financial services and insurance (BFSI) companies in US and Europe, a large customer segment for Indian IT companies.
With commentary at the clients’ end turning cautious, analysts fear IT spends will be tempered, weighing on local companies revenue growth.
“The negative news flow from the BFSI vertical thus far has been on capital market oriented financial institutions. However, we believe that the malaise is spreading to the lending and insurance sides of the business," Nirmal Bang Institutional Equities said in a note.
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