IT: The rupee effect

Indian technology firms have been grappling with a slowdown in the US economy, one of their biggest markets that contribute almost 50-60 per cent of revenues. In particular, the crisis in the financial space has meant less business from that segment which contributes about one-third of IT revenues. The Rs 22,861 crore Tata Consulting Services, which has the highest exposure to the financial sector, could see revenue growth slowing down.

With a slowdown evident in the UK and Europe too, the environment is challenging for IT majors, and the September quarter results are not expected to be too encouraging.

However, the respite could come from the falling rupee. It has been seen that a one per cent depreciation of the rupee against the dollar typically helps push up operating margins for IT firms by around 30-50 basis points. So, the rupee depreciation by 8 per cent since the start of July will definitely add to the top-line, but the dollar has appreciated against the pound and Euro by 9 and 8 per cent respectively during the same time.

Thus, the rupee growth seems likely but dollar growth is expected to be subdued. In the June quarter, companies incurred forex losses and the September quarter would be no different though the movement in currency should help all players. Infosys and Satyam, which use a mark-to-market hedge, should gain more.

Infosys stands to gain because of its smaller forex cover. On the other hand, TCS and Wipro, which follow a cash flow hedge accounting policy, could see a large part of their losses reflected in the balance sheet rather than the income statement. But it should be noted that even in the June quarter, TCS had a sequential increase in revenues of just 5.2 per cent at Rs 6,411 crore despite the falling rupee. Even in dollar terms, the growth was just 0.5 per cent. Peer Infosys had done marginally better growing revenues by 6.8 per cent q-o-q.

The BPO business for Satyam could see robust growth as the animation contract that was not extended in the June quarter resumed this quarter. However, operating profit margins for Satyam and Wipro might contract due to wage hikes. Infosys and TCS had introduced their hikes in Q1FY09 and with the currency movement could see expansion in their sequential operating margins.

The growth in volumes for tech firms was muted in the June 2008 quarter with TCS just adding 35 clients. Infosys did manage to add 49 clients in the June quarter, one of the highest additions in a long time. But given the economic environment and IT spends almost certain to be lower this year, volume growth could remain muted. It is believed that offshoring could pick up later in the year. But vendors are unlikely to be able to realise better prices in a difficult environment.

The BSE IT index has outperformed the market since January 2008 falling by 28 per cent compared with a 36 per cent fall in the Sensex. At Rs 1,453, Infosys is valued at 14 times its estimated price earnings for FY09. At Rs 671, TCS trades at 10 times its FY09 estimates. Possibly because of its poor performance in the June quarter, Satyam commands a price-earnings multiple of just under 9 times forward while Wipro trades at 13.5 times.