The Nifty IT index slipped 1.31% in Aug even as the rupee fell 3.70% against the dollar
A Falling rupee means higher dollar earnings for IT firms, but larger concerns hit IT stocks in August
Technology investors typically take heart from a falling rupee as it promises higher dollar earnings, but August was different, as larger concerns weighed on these stocks.
The National Stock Exchange’s (NSE’s) benchmark Nifty IT index has slipped 1.31% in August so far, even as the rupee fell 3.70% against the dollar. Top IT stocks like Infosys Ltd, Tata Consultancy Services Ltd and Wipro Ltd are down 2-5% during the month.
Analysts said technology stocks fared poorly in the June quarter as well, while the outlook for the rest of this fiscal year remains bleak. Ravi Menon, lead analyst for IT at Elara Capital said investors are still cautious on technology stocks due to the weak guidance offered by the managements at various companies. “Though the decline in rupee means higher margins for IT companies, only a sustained weakness in the local currency will benefit these companies," Menon said.
In this year so far, the rupee has fallen 2.34% although it strengthened 0.33% in July. The managements have pointed to weakness in the US and Europe, as well as the banking, financial services and insurance (BFSI) sector. Low unemployment levels in the US, high attrition, a tightening visa regime and pricing pressure on traditional projects have been the main factors behind the contraction in gross margins, said analysts.
The Nifty IT index rose 23.78% and 12.18% in 2017 and 2018, respectively, while the benchmark Nifty was up 28.65% and 5.91% in both years. In 2018, the rupee weakened 8.45%, while it strengthened 6.34% in 2017.
“Tier-I IT pack delivered constant currency revenue growth of -1%-4.2% q-o-q while tier-II delivered dollar revenue growth of -5.2%-4.7% on sequential basis. Firms under our coverage are uncertain on Q2 revenue growth (TCS, Wipro) which could incrementally reflect on FY20E growth," brokerage Prabhudas Lilladher said in a report on 14 August. “Guidance cuts or caution was given by L&T Infotech (mentioned improvement Q3 onwards), L&T Technologies cut guidance from 14-16% to 12-14%, weakness due to hi-tech & telecom…Infosys is the only exception to have raised FY20 guidance from 7.5-9.5% to 8.5-10%," it said.
According to Prabhudas Lilladher, the factors which led to margin decline include increase in sub-contracting cost, higher visa costs, rupee appreciation, large deal transition costs and continued pressure on realization. “However, we believe that Q1FY20 will be the bottom for margins and we can see margin uptick in coming quarters. Though the scope of margin improvement will be minimum as rupee will act as a headwind," the analysts wrote.
Weak macros in the US and Europe will translate into slower demand, while weakening of BFSI and manufacturing, legacy businesses which still constitute two-thirds of tier-I IT revenues have been dragging overall growth in the sector, analysts said.
“Most of the tier-II firms reported either vertical-specific or client-related issues that drove sharper deceleration in their revenues. Y-o-y growth gap between Tier-I and Tier-II was at its lowest in the past eight quarters at 0.5%. Led by revenue under performance and aggravated decline in margins, valuations gap between tier-I and tier-II is now at over 30% versus negative 8% two years ago," said Motilal Oswal Financial Services.
Hiring continued to gain pace with net addition of 27,313 employees by the top five IT firms in Q1. TCS topped the list of net additions among the large cap firms with 12,356 employees followed by HCL Tech with 5,935. However, attrition continued to remain elevated for all IT firms with supply side crunches led by lower unemployment rate and H-1B visa policy.