Low hedging dents mid-cap IT firms' margins

BS SPECIAL

Prompts them to run for better forex cover.

The top-tier information technology (IT) service providers have managed to stay afloat in the quarter ended July 30, 2007, despite rupee appreciation thanks to their hedging strategies.

The latest example being HCL Technologies, which managed to salvage its net profit by posting a forex gain of Rs 250.40 crore. However, small- and mid-cap IT companies were not so lucky.

Unlike the top tier IT companies, most of the mid-cap firms do not have access to resources to go in for hedging while there were some who clearly didn't see it hitting them so badly, analysts reason. 
 

STAYING AFLOAT As on March 31, 2007
($ mn)	Currency hedges
Sasken	54
Polaris	49
Aztecsoft	40
Geometric	39
Mphasis	30
NIIT Tech	29
iGate	27
KPIT	18
Mastek	13

Besides, many companies did not factor the longer period for hedging, with most of them considering only for two to three quarters.

For one, the first quarter of any financial year is generally tough as companies have to factor in wage hikes. Besides, this quarter (April-June 30, 2007) delivered a triple whammy "" a wage hike of 15-17 per cent, rupee appreciation of 7 per cent against the US dollar and visa fees hike. And the results were for all to see.

Geometric Software Services' operating margins (EBITDA), for instance, fell almost 6 per cent when compared with the previous quarter's figure. The wage hikes adversely impacted the operating margins by a little over 4 per cent.

In case of Hexaware Technologies, whose operating margins took a hit of 2.8 per cent, the company was prompted to declare that it would not provide further guidance until the rupee stabilises.

There are analysts who feel it is difficult to categorise these companies due to their niche operations. Besides, companies like 3i Infotech and Rolta with a strong focus on the domestic market have not registered any impact of the rupee appreciation.

Harit Shah, senior analyst, Angel Brooking, said, "These companies will bounce back in the next two quarters. This quarter was very volatile. Despite hedging, mid-cap companies will be affected as they have a small base."

Akash Gopowar, senior analyst, Systematix Shares and Stocks, concurs, "Despite the hit, none of the companies are going slow on their expansion plans. That shows that business is growing and their order books are healthy."

Moreover, lessons have been learnt and many companies are getting their act together. Most of the mid-cap companies are factoring in more than three years for hedging and taking good foreign cover. Hexaware currently has a forward cover in excess of $90 million at an average rate of Rs 42.29.

All companies are going in for an increase in billing rates in the range of 2-5 per cent. iGate, for instance, has said they will be announcing a price hike. It has also announced a hike of 2-2.5 per cent in the offshore rates and 1-1.5 per cent hike in onsite rates. And finally, these companies are also increasing their productivity.

Another instance is KPIT Cummins. The company has used offshoring as a margin lever effectively over the past two to three years (offshore revenue as a percentage of total has grown from 32 per cent to around 50 per cent in Q4 '07). Moreover, the company is focusing on higher-margin of offshorable services.

But analysts fear that the strategy of hiking the billing rates might not work well.

"Increasing the rates for new contracts is fine but to increase the price for an existing customer is difficult," said an analyst.