Not so dark Q2 for IT

The appreciating rupee took the wind out of the sails of IT companies in the first quarter of current financial year. In rupee terms, a majority of Indian IT companies either posted flat revenues or witnessed a drop in profits.

But the second quarter should be better, according to analysts, as the rupee has appreciated by only 1.5 per cent against the dollar sequentially (over the previous quarter) as compared with nearly seven per cent in the first quarter. Besides, the first quarter is considered to be "seasonally weak" for IT firms.

The rupee has appreciated 12.6 per cent against the dollar, on a year-on-year basis, which implies that the year-on-year comparisons could see a drop. 
  

SITTING PRETTY Scenario analysis
	2008-09E	2009-10E
(Rs/$)	40	39
	P/E ratio
TCS	20.3	17.3
Infosys	23.2	19.5
Wipro	19.9	17.2
Satyam	18.3	15.1
E: Estimated Source: Angel Broking (Sept.)

Every one per cent rise in the rupee against the dollar shaves off about 35-50 basis points from operating profit margins, as IT companies have anywhere between 40 and 70 per cent exposure to the US markets.

For the quarter-ended September 30 (the second quarter for a majority of companies), Indian IT firms are expected to post a 7-8 per cent sequential growth (as compared with the previous quarter) in top line (implying volume growth), and a bottomline growth of 7-7.5 per cent.

IT bellwether Infosys and India's largest IT services provider Tata Consultancy Services (TCS) are expected to post stronger results. TCS' shift towards higher margin businesses, a diversified geographical base, full services play model (IT, BPO and infrastructure services) and near-shoring are expected to propel growth.

Satyam's profits, on the other hand, could take a hit as it will have to account for wage hikes during the quarter. Wipro, too, will have to account for marginal wage hikes in the quarter, putting pressure on margins.

Wipro's acquisition of Nasdaq-listed Infocrossing for about $600 million (Rs 2,400 crore) will be completed by November, which is why analysts do not expect it to have any impact on the numbers this fiscal.

In the case of HCL Technologies, it will not have the benefit of the sizeable other income which boosted profits in the first quarter.

Top IT companies have been adequately hedged (anywhere between $400 million and $1 billion). Mid- and small-caps, on the other hand, may not be as lucky.

Most of them had reported a 10-30 per cent dip in net profit as compared with the trailing quarter net profit figure.

Hexaware Technologies, which posted a nearly 26 per cent drop in net profit as compared with the previous quarter, decided "not to provide further guidance till the rupee reaches a relatively stable level."

Incidentally, a majority of IT service providers have said they would not be hit by the US sub-prime lending crisis that has had a cascading effect on global stock markets.

Meanwhile, IT companies have managed to effect a 3-5 per cent hike in billing rates. Every one per cent increase in pricing translates into a 75 basis points margin improvement.

They have also improved employee utilisation rates, managed wage cost by hiring freshers and are moving to other geographies where the currency impact is lower. The benefits from this should kick in, but with a lag. The key differentiator would be how quickly the companies manage costs.

Moreover, Indian IT companies are taking a serious look at the domestic market to beat the dollar blues. The Indian domestic outsourcing market is estimated at $2.2 billion (about Rs 8,800 crore), if one considers only deal sizes above $50 million (Rs 200 crore).

Overall, analysts believe that the recent correction in stock prices of top-tier IT stocks, "while not entirely unwarranted, has been overdone by the market."