Margin blues for tech majors

The information technology index of the Bombay Stock Exchange fell 2.48 per cent today - the sharpest among all sector-specific indices - amid fears that the rising rupee may erode operating margins.

When the dollar weakens against the rupee, as is happening now, IT companies get hit harder since many of them earn mainly in foreign exchange (read dollars) but spend and account in rupees. The impact is more on companies that have a higher percentage of revenues coming from their offshore businesses.

Hexaware took the hardest hit when it fell 7.44 per cent on the bourses, Infosys Technologies was down 2.2 per cent, Tata Consultancy Services (TCS) fell 2.4 per cent, while Satyam Computer Services dropped 4.9 per cent. Wipro declined 2.1 per cent.

As a thumb rule, say analysts, every percentage rise in the rupee impacts operating margins by anywhere between 25 and 40 basis points and this negative sentiment was reflected in the markets. Analysts add companies that have not hedged the rupee satisfactorily will be the worst hit. When the rupee appreciates, they get fewer dollars in receivables.

The results are here to see with two Indian IT majors having posted their results. For Tata Consultancy Services (TCS), the rupee impact on the fourth quarter revenues was 1.87 per cent and 0.57 per cent on the net profit. However, the company registered a pricing growth of 89 basis points this quarter to offset part of the rupee impact.

The dollar traded at an average of Rs 43.75 in the fourth quarter, weakening from Rs 44.22 during the corresponding period last year. It had a 100 basis points effect on the margins of Infosys Technologies.

"The rupee appreciated against all major currencies during the quarter. But our robust financial model allows us to balance the investments required in business and profitability while focusing on growth," Infosys CFO V Balakrishnan had said. Infosys' rupee term revenue guidance for 2007-08 is 23-25 per cent and earnings per share (EPS) guidance is 20-22 per cent owing to the appreciating rupee scenario.

In the third quarter ended December 31, 2006 too, the rupee had appreciated by 2.31 per cent against the dollar over the corresponding quarter's figure last financial year to touch an average of Rs 44.36. This impacted the operating profit margins (OPM) of the IT majors. In the case of Infosys Technologies too, this impacted the company's YoY operating margins by 128 basis points from 34 per cent in the December 2005 quarter to 32.72 per cent for the December 2006 quarter.

Hedging does provide a measure of safety though. Infosys said it was hedging $470 million at Rs 43.10 during the first half of FY08, which should be effective in warding off the adverse consequences of any further appreciation of the rupee.

TCS too has provided a forward cover of $1 billion for 2007-08.

While the remaining fourth quarter (and full-year) results of most IT companies will tell the whole story, analysts are expecting the mid-cap IT stocks especially to be hit harder since they may not have factored in the rising of the rupee to this extent.