Stronger rupee in Q1 may spell trouble for margins of IT companies

Wage hike in April-June and rising onsite cost regarded as other headwinds to margin profile of IT companies.

A stronger rupee against the US dollar in the ongoing quarter of the current financial year is likely to further strain the margin profile of domestic information technology (IT) services companies, which continue to reel from the burden of rising visa fees along with pricing pressure in clinching outsourcing contracts. Industry experts are of the opinion that IT services firms may see around 30 basis points (bps) impact on their operating margins owing to a stronger rupee.

The Indian currency has gained around Rs 1 on an average basis from January this year till June first week. In the April-June period so far, the gain is around 30 paise on an average basis. The rupee is currently hovering around 69.4 against the US dollar.

“Any appreciation in the rupee will affect the margin profile of domestic IT services companies. As a thumbrule, 1 per cent change in the rupee-dollar value usually has a 30-40-bps impact on operating margins,” said V Balakrishnan, chairman of Exfinity Venture Partners & former chief financial officer and board member of Infosys.

He, however, said the impact of the recent appreciation in the rupee against the dollar would depend on the treasury management approach of individual companies, apart from their ability to withstand pricing pressure in the market.

“The IT services industry is getting commoditised with each passing quarter. So, the reflection of the rupee movement on the margin profile is getting muted in recent years,” added Balakrishnan.

Domestic IT services companies are facing margin headwinds, owing to severe competition for winning outsourcing contracts, leading to pricing pressure. Similarly, the rise in onsite hiring, especially in the US, apart from wage pressure in India, are some of the other factors driving margin profile downwards.

In a recent report, credit rating agency CRISIL has said Indian IT companies would continue to face risks to their profit margins in the coming years. “Margins have been declining structurally for the past five financial years (for Indian IT services firms). As billing rates and utilisation stabilise, rising employee costs will only add to this pressure,” CRISIL said in the report.

The trend of decline in operating margins has already been reflected in the financial statements of all big firms. For instance, Tata Consultancy Services’ operating margin declined to 25.6 per cent in 2018-19 (FY19), compared to 26.9 per cent reported in 2014-15 (FY15). Similarly, Infosys’ margin dropped to 22.8 per cent by the end of March 2019, against 25.9 per cent reported in FY15.

Apart from these two big firms, HCL Technologies had also witnessed a drop in its operating margin by 70 bps at 17.9 per cent in FY19. “Operating margins are likely to decline by another 30-80 bps in the current financial year for Indian IT services players,” said CRISIL.

While factors like a stronger rupee, rising onsite cost, and higher sub-contracting expense are likely to play out in the current quarter, analysts are expecting margins to get further affected due to wage hike for employees in offsite locations.

“Most tier-I companies have given around 6-7 per cent hike to their employees in India. So, a wage hike will definitely cut into margins. But, it is to be seen how much of it is offset through automation and other operational efficiency measures,” said an IT sector analyst.