Will IT stocks repeat Q2 performance in Q3?

The BSE IT index had reported its sharpest quarterly gain in past four years in last quarter on hopes of improved growth outlook for the current fiscal from the US and rupee depreciation.

The BSE IT index had outperformed the Sensex by surging 25% between July-September (Q2) as compared to a marginal 0.08% drop in the benchmark index. The IT index had reported its sharpest gain since September 2009, when it rallied 39% during the quarter.

HCL Technologies, Wipro, Tata Consultancy Services (TCS), Tech Mahindra, Hexaware Technologies and Persistent Systems had surged between 26-50% during the recently quarter. Infosys, MphasiS and eClerx Services gained in the range of 17-21%.

An over 20% fall in the Indian rupee (INR) against US dollar (USD) since May 22, when the US Fed first indicated that it might start tapering its bond buying programme earlier than expected, led the rally in IT stocks. The rupee had depreciated 24% from 54.89 on May 22 to a record low of 67.73 on September 3.

IT companies earn most of their revenues in dollars. So, each dollar earned abroad would get them more rupees.

According to analysts, the EBIT margins for the larger, Tier-1 IT companies typically moves 25-35 bps for every percentage change in the Rupee/USD equation (or about 1.5-2.0% at the PAT/EPS level).

With resumption of foreign institutional investors (FII) flows and reacting to the recent steps taken by the Reserve Bank of India (RBI) to stem rupee’s fall, the rupee appreciated against USD and gained 7.7% since September 3 (from 67.73 to 62.47).

Thanks to RBI steps and slightly better CAD (current account deficit) data, rupee was the best performing Asian currency since September 3, gaining against most major currencies including British Pound, Euro, Japanese Yen and Canadian Dollar.

Outlook

So, will the IT shares sustain the same growth in October-December (Q3) quarter as the rupee has bounced back nearly 8% from its record low touched in last month?

The Street is justifiably enthused by the prospects for the Indian IT sector invoked by the depreciating rupee but we do not see this as an unqualified godsend, an analyst at JPMorgan said in a note on Indian IT services on September 11, 2013.

“We think that the volatility of the INR will test the strategic decision-making skills of Indian IT companies. It can play testing psychological games with companies as not everyone will emerge from this a winner if some scenarios that we envision pan out,” added the report.

Meanwhile, analyst at Sharekhan recommended TCS and HCL Technologies among top picks with target price of Rs 2,160 and Rs 1,187 respectively.

“In the current environment, we believe HCL Tech is well placed in terms of its business strategy of consciously targeting the re-bid market,” he says

“Among the top four IT companies, HCL Tech is relatively better placed, as around 50% of its total workforce in the USA holds the H1-L1 visa against a higher percentage of such visa holders for TCS, Infosys and Wipro,” he added.