Even as the northern part of the country banks on the monsoon to bring some relief, bean counters sitting in the cool environs behind the glass facades of Indian IT companies are waiting for another overheated counter to taper off. For, with the Indian economy growing at a sizzling 9.4% and inflation at around 5%, it is the appreciating rupee — unprecedented in scale and timing — that has sent IT firms back to the drawing board. Reason: they had given earnings guidances based on the assumption that the dollar would hover around Rs 43, but the rupee has appreciated by about 8.7% in the last couple of months to hit 40.80 to the dollar. As a result, firms are staring at the real possibility of having to go for a downward revision of guidance.
Though there’s still a couple of weeks for earnings season to start, officials of top IT companies admit that they are evaluating all possibilities, including a downward guidance revision. Some, though, are still unwilling to go on record. “I definitely see companies going for a downward revision of annual earnings. From the levels that we had estimated, it (rupee) has appreciated quite a lot and there is a huge gap that is now difficult to bridge,” a top official of an IT major said.
Others are not that coy. Asia’s largest software exporter Tata Consultancy Services (TCS) is clear that the appreciating rupee is a cause for concern. “It (rupee appreciation) is impacting us. We have been hedging and so on and we have built up some positions. But we are booking revenues at lower rates,” says TCS chief financial officer S Mahalingam. If that's the case with the Rs 18,685-crore software behemoth, the Rs 605-crore Pune-based IT firm Zensar Technologies Ltd is also dismayed by the turn of events. “The dollar has depreciated lower than we would expect it to,” said chief financial officer S Balasubramanium.
The apex body of software exporters, National Association of Software and Services Companies (Nasscom), has also expressed its apprehension that a stronger rupee could hurt the industry. “We have had a 8-9% increase in the value of the rupee in the last three-four months. The entire industry is greatly concerned about this,” says Nasscom president Kiran Karnik.
WHY THE CONCERN?
The rupee appreciation against the US greenback has only compounded the woes of the Indian IT industry that’s already burdened with rising costs due to wage increases — an average of 15% per annum — high attrition and over-dependence on the US market for business. On an average, Indian software firms get 60% of their revenues from the US and 1% appreciation of the rupee against the dollar can impact earnings before interest and tax margins by between 30 and 50 basis points. “Irrespective of the fact whether the company is big or small, all of them have been hit. The margins may be impacted by as much as 4%,” says Rostow Ravanan, chief financial officer of Bangalore-based MindTree Technologies.
Karnik says that most companies were able to manage the wage increase and high attrition rates so far. “But if wage costs increase and on top of that there is a dollar depreciation, we are going to have a problem” he feels.
For instance, Infosys’ forecast of 22% earnings growth is based on an exchange rate of Rs 43.10, while Satyam’s 20% is based on Rs 42.30 per dollar. “Both Infosys and Satyam will be headline cases for currency impact as both will need to reset full year guidance to new currency levels, come July,” investment bank CLSA has cautioned clients. Though companies like Infosys, TCS and Satyam have also increased their foreign exchange hedge from the March 31 levels, analysts feel this is only a “slight mitigant”.
While TCS increased the hedge to $1.5 billion from $1.2 billion in March 31, Infosys forex hedge is approximately $1 billion and Satyam’s is at $650 million, up from about $470 million. “If you look at the relative size of these companies, this can only be a slight mitigant to the effects of an increasing rupee,” says an analyst with a Mumbai-based foreign brokerage house. “The situation now is that the rates available both for spot and forward premia are not good enough to hedge. What we are trying to do is to go in for a big syndicating rupee loan with a dollar swap option,” Ravanan said.
BUT ALL IS HARDLY LOST
In general, IT companies are putting up a brave front and hoping that the rupee will start depreciating post-July. Also, they hope to neutralise some of the impact by increasing productivity, increasing prices and better utilisation of resources. Some analysts are also hopeful that the demand environment being favourable, companies may not actually have to go for earnings revision. “Volume growth, pricing and demand environment are all positive. We are even seeing a 2-4% price rise by these companies. In the last fiscal, there was an average volume growth of 30% and hopefully it will at least be maintained this year,” says Harit Shah, IT analyst with Mumbai-based brokerage house Angel Trade.
Investment bank Morgan Stanley in its note to clients has expressed optimism that companies will be able to meet guidances. “Given the robust demand environment and possible margin levers in the form of utilisation, the companies should be able to meet guidances despite significant rupee appreciation recently,” it predicts. Taking the examples of Infosys and Satyam, the brokerage house points out that Infosys will need to record average sequential dollar revenue growth of about 8.5% to 9% each quarter and Satyam about 8% to meet its earnings guidance. For the financial year 2006-07, Infosys had an average quarterly growth of 9.5%, while Satyam had 7.5%. Besides, it says that strong volume growth — the four largest companies reported over 35% rise in FY07 — will be maintained this year too.
“Pricing has also improved steadily in the last four to six quarters - Infosys' average offshore and onsite pricing increased by around 2.7% and 4.4% in FY 07 respectively” notes Morgan Stanley. “There is not much hope in June as there are going to be large equities inflow through public issues like ICICI Bank, DLF etc. But post-July, the rupee may start depreciating,” says MindTree’s Ravanan. “The industry belief is that this depreciation (of dollar) will not persist,” adds Zensar’s Balasubramanium.
THE WAY AHEAD
“There is a reasonably steady kind of pricing environment and some prices are even being renegotiated,” says Ravanan. “So, it is still possible to increase revenue in spite of the rupee rise.” The other aspect is derisking the businesses by concentrating on non-dollar territories. “Zensar has its fastest growing market in non-dollar territories with nearly a third of its business from countries outside of the US and the UK,” says Balasubramanium. Morgan Stanley also believes that forward contracts and currency hedges should generate some gains on the "other income" line on the assumption that the average exchange rate will be Rs 41 per dollar in financial year 2007-08.
However, having said all this, the first quarter results that will be announced in July will definitely see companies under pressure from the rupee. “I don’t think there will be any formal commitment on the earnings guidance,” feels Ravanan. “It’s too early in the year and people don’t want to give a negative outlook.
But there will be a lot of qualitative and cautious comments from companies. They would like to wait for one more quarter, but how much can be done is anybody’s guess.” What is clear is that it will be negotiating clout, efficiency and maximal utilisation of resources that will finally decide the fate of the guidances issued. As they should, in any true market.
Source : FE
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