Brexit: 4-7% earnings impact for Indian IT firms

Revenues, profit margins will be hit in the next one year, but more demand in the longer run

Indian IT (information technology) companies will be hit by Brexit (UK exit from European Union) in more ways than one. First, these companies, which have seven to 13 per cent exposure each to pound-denominated revenues (20-30 per cent each to euro), will witness some operating-profit margin pressure as the euro and pound weaken against the dollar. Second, their dollar revenues could lose some sheen, too, due to cross-currency headwinds. Though this impact is immediate, the strength of the dollar versus the rupee could offset some of this pressure. "By our analysis, rupee depreciation of three-four per cent is necessitated to offset the earnings impact of 10 per cent depreciation of pound and euro against the dollar," says Govind Agarwal, IT analyst at Prabhudas Lilladher. While most analysts expect IT companies' profits to be hit, Agarwal believes revenue and profit margin impact could slice off four-seven per cent of profits of top IT companies.

Third is a more structural near-term hit in the form of lower client spends, especially by banking, financial services, and insurance (BFSI) in the UK and European Union. UK-based manufacturing companies exporting products to Europe could also lower their IT spends, believe analysts. While companies do not share region-wise break-up of revenues from different sectors, Sagar Rastogi, technology analyst at Ambit Capital, says that among large IT companies, HCL Technologies, Tata Consultancy Services (TCS), and Infosys get most revenues, 17, 13, and 11 per cent of total, respectively, from Europe-based BFSI companies. He believes these companies are most vulnerable to any slowdown in IT spends.

Overall, HCL Tech's exposure to Europe is 28 per cent of total revenues, while that of Infosys is 23 per cent, TCS is at 27 per cent and Wipro at 26 per cent. Others likely to see an impact are Tech Mahindra (Europe revenue exposure 29 per cent), NIIT Technologies (27 per cent), and Mindtree (25 per cent).

  Against this backdrop, it is not surprising the BSE IT index is down four per cent since Friday versus 2.2 per cent for the Sensex. On Monday, BSE IT index was down two per cent against a flat Sensex. The coming US elections and the commentary around visa and immigration norms will be additional factors keeping these stocks in check in the near term. Analysts say demand for technology and offshoring could increase in the medium term as companies resort to technology to meet regulatory guidelines and clients' business requirements. But for now, the pressure on the stocks could continue.

Offshoring refers to basing some of a company's processes or services abroad, to take advantage of lower costs.