Structural slowdown & currency appreciation to impact margins
So far, it has been a case of choosing the lesser evil for the market. So, though the technology sector has been seeing a secular slowdown and business has become very competitive, the market has been betting heavily on it. Stocks of information technology IT) companies rallied 8-10 per cent prior to some of the big global and domestic announcements, as there were few options.
The outlook for the sector, however, has changed since September 13, after the US Federal Reserve announced its latest stimulus package. Under this programme, mortgage-backed securities worth $40 billion will be bought each month. This will infuse substantial liquidity in the system and the perception is that some of it will find its way into emerging markets like India. Higher capital flows will help prop the rupee. Those looking for evidence need to look at inflows in September alone, which has seen FII inflows of $1.69 billion.
In the first quarter, the 9.36 per cent fall in the rupee helped shore the profitability of IT service companies. This might change in the second quarter, as the rupee has appreciated 4.5 per cent in September itself. Most economists believe the rupee will strengthen over the next few months as flows pick up, which will erode margins of these companies.
Other than this, analysts say even if the rupee does not strengthen as much as expected, the IT sector is facing several challenges For starters, analysts believe companies might not be able to keep all the currency benefits. According to Kotak Institutional Equities, IT companies (with the limited exception of HCL Tech) have been barely able to retain margin benefits despite, depreciation of the rupee against the dollar.
The brokerage believes this trend is unlikely to change for two reasons. First, the companies are re-investing gains to expand addressable opportunity. Also, customers are demanding that companies pass some of the benefits of currency deprecation back to them. Though this is happening in a staggered manner, it is sure to impact the financials of companies. Also, analysts say there is a structural demand slowdown in the sector, which is not showing signs of revival. A combination of these factors is likely to keep any further uptick under check.
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