In the past 3 months, rupees has depreciated by 7.5%. If someone wants to know that what impact this will have on the profits of IT services companies, the last place they should look is a research report by sell-side research firms. Analysts at these firms are always in agitation that when will the rupee is in free fall. Investors invariably turn bullish on stocks of exporters when the local currency depreciates.
The supposition is that rupee proceeds from projects billed in dollars will be far greater than earlier anticipated. Apart from that a large part of these companies expenses are in the local currency means that margins can get a sizeable promotion. The problem is that things don’t work out as cleanly after viewing the past experience.
When IT projects come up for the rebuild, clients consider the fall in the rupee and then renegotiate billing rates with Indian IT service providers. This is one of the reasons gains from the rupee have not stayed on the profit and loss statements of the Indian IT industry for long. In the past few years, despite a weaker rupee, margins have been declining for Indian IT.
There may be near-term gains, but unless there is a continued slide in the rupee, gains won’t last beyond a year. Then there are losses on forex hedges to reckon with, which limit the extent of benefit in the near term as well for some companies.
In the current fiscal year, it is expected that It firms will get some boost. While in FY20 there may well be a drop in earnings unless the rupee slides another 8-10% in that period as well. That is because with that time gains from the rupee would have been largely given over to clients during deal renegotiations.
When some enthusiastic analysts try to figure out to investors, the response they typically get is, “We’ll consider that when we come to that bridge”.In this generally upbeat scenario, hardly any analyst wants to stick their necks out and told in a research report that the excitement about the rupee depreciation is overdone as far as IT stocks are concerned. Why, they may even lose their jobs, since such a call will lead to big underperformance.
Analysts expect of how much an IT company’s profit margins will expand for every one percentage point depreciation in the rupee. On an average, this works out to about a 20-25 basis points growth to margins. Since early June, the 7.5% fall in the rupee could boost margins by nearly 200 basis points.
Analysts call has proof right again yet as IT stocks are on the fire. Since early June, the Nifty IT index has risen 20% and has outperformed the Nifty 500 index by 12.5%. Valuations of popular IT stocks were already well over 20 times forward earnings. They have now crossed historical averages by a wide margin.
Surely, this may not end in a very well way but we can all consider that when we come to that bridge.