Mixed fortune for IT small-, mid-caps in Q2

Unlike the first quarter of FY08 when Indian IT small- and mid-caps were hit hard due to a nearly 7 per cent appreciation in the rupee against the dollar, the July-September period was relatively kind to these firms. It spared them to some extent, since the rupee appreciated around 1.5 per cent over the period.

However, the rupee rose around 12 per cent against the dollar over the last 12 months. Consequently, of the 13-odd small- and mid-cap IT results declared so far, three firms took a beating of over 20 per cent on their year-on-year (YoY) profit margins.

Others showed a slowdown in their annual growth figures, besides a dip in their sequential operating margins (EBIDTA). Every percentage rise in the rupee shaves off 30-50 basis points from the margins.

Hexaware, for instance, saw its PAT dip 22.4 per cent y-o-y, but its revenue was up 13.2 per cent. Sequentially, its net profit saw a marginal 3 per cent rise.

It, however, added 15 new clients, and boasts of its highest-ever order book of $100 million. Mid-tier product engineering and testing company Aztecsoft witnessed a 39.5 per cent dip in its YoY net profit at Rs 6.93 crore.

The dip was attributed to the transfer of the Indian offshore development centre (ODC) to the US-based Dendrite Inc.

Polaris Software was the worst hit. It reported a 33 per cent drop in its net profit at Rs 18.22 crore. "Though we had our hedging strategy in place, the rupee appreciation severely impacted our bottom line," reasoned R Srikanth, chief financial officer, Polaris Software.

The company's EBITDA fell 22 per cent to Rs 34.26 crore for the second quarter. However, its revenues were up 7 per cent to Rs 273.55 crore. On a sequential basis, though, its net profit was up 26 per cent.

Rajesh Cheruvu, fund manager, PMS, Axis Bank, says, "For the overall industry, we are positive. However, mid-cap IT companies have not been doing well. Why should one pay a premium for mid-cap stocks which are growing at the rate of 25-30 per cent?"

Another analyst, who did not wish to be quoted, said, "There will be a few companies who will do well this quarter primarily due to their focus on the domestic market (such as Rolta, 3i Infotech, and Geodesic)."

KLG Systel, for instance, saw a 212 per cent increase in its net profit since it has a "a 100 per cent domestic business, and provides IPR services to Indian companies".

Moreover, unlike the top-tier IT companies, small- and mid-caps neither have ample cash reserves nor can they hedge for a longer period. They will get hit unless they innovate, serve niche offerings or have a products-based portfolio too.

For instance, Hyderabad-based telecommunications software and services provider, Tanla Solutions, registered an 86 per cent growth in consolidated net profit.

The company stated that the cost of sales had fallen from 48.9 per cent to 44.4 per cent as a result of increased platform capabilities, R&D, and better cash management.

The firms are also learning to cope with a harsh rupee environment by improving their efficiency. Companies such as Polaris have been focusing on improving employee utilisation, cost structures and adopting a prudent hedging strategy to counter the rupee appreciation. Its utilisation, for instance, improved by 200 basis points this quarter.

iGate managed to double its profit to Rs 22.9 crore during the second quarter, attributing it to operational efficiencies, including reducing its direct costs.

Even a small company like Hyderabad-based Mold-Tek Technologies saw its net go up by 67 per cent Sby executing larger structural knowledge process outsourcing (KPO) engineering projects.

Going forward, the third quarter has fewer working days, and the rupee is expected to be range bound with the Sebi curb on participatory notes restricting FII inflows. IT firms can keep their fingers crossed.