Rupee fall: Why HCL, Tech Mahindra score over Infosys, TCS

A 15 per cent fall in the Indian rupee since May 22 (when the US Fed first indicated that it might start tapering its bond buying programme earlier than expected) has led to a 30 per cent jump in IT stocks. In contrast, the BSE Sensex fell 4 per cent during the same period. Clearly, investors latched on to IT stocks on hopes that earnings per share (EPS) and dividends will go up for these stocks. But, does a fall in rupee really guarantee higher margins and return?

1. Not really. Investors expect exporters (such as IT outsourcers) to benefit from rupee fall because a large proportion of costs of such firms are in rupees, while revenues are largely in foreign currency (say dollars). The assumption that margins (profits) will rise because of falling rupee lies in the reasoning that companies will pass benefits from rupee depreciation to investors. But this might not happen. In the past, some clients asked for a discount as rupee fell, while others negotiated (drove down) prices before signing a deal. Ashwin Mehta and Pinku Pappan of global brokerage Nomura have busted the myth that rupee fall leads to higher margins for IT firms in great detail.
2. What happened in the past? Only two companies (HCL Tech and Tech Mahindra) saw material margin benefits in the past leg of rupee depreciation (from 50 to around 57 per dollar during March 2012 to June 2013). Margins for TCS, Wipro and Infosys actually declined. That's (partly) because rupee depreciation benefits were offset by higher (onsite) costs for Infosys. TCS agreed to lower pricing to gain market share, while Wipro invested (part of the benefits) in sales. Cognizant was hit by hedging losses.
3. What about the recent rupee crash? The rupee depreciation in the September quarter has been "too sharp too soon" so margins/earnings may show improvement, even for companies that did not show benefits in the last leg. That's because reinvestments only happen at a more gradual pace (unlike the sharp fall in the rupee). Also, improvement in demand outlook in the U.S., the biggest market for Indian IT outsourcers, and a pick-up in discretionary spend is likely to reduce pricing pressures on Indian companies.
4. Which companies will see the biggest upside? HCL Tech and Tech Mahindra will continue to be the big gainers. That's because these companies face fewer headwind over say Infosys and TCS. Over the last three quarters, HCL has signed large deals (over $3 billion) when rupee was between 54 and 59, while Tech Mahindra guided to keeping margins stable at around 21 per cent if the rupee held at near 60 levels (margins will go up sharply as rupee is near 65-66/dollar today). In contrast, Infosys faces a 300 basis point margin headwind from wage increases, which will likely be offset by rupee depreciation.
5. Cognizant to benefit the least: Among large firms, Wipro and Cognizant will be worst hit due to their hedging strategies. In a presentation at Citi 2013 Global Technology Conference, Cognizant president Gordon Coburn said, "We're probably the most heavily hedged in the industry. We're hedged through 2016, before the hedge every 1 per cent movement in the rupee impacts our operating margin by 23 basis points. After the hedge every 1 per cent movement in the rupee impacts our margin by roughly 10 basis points."
   shailendar kumar 
   pgdm 1st year 

Story first published on: September 09, 2013 14:13 (IST)