Rupee’s resurgence to snap uptrend in IT cos’ shrs FY20

Cogencis, Friday, Mar 29

By Nikita Periwal

MUMBAI – A resurgent rupee, higher employee costs, and investor preference for domestic consumption-driven companies will likely weigh on shares of information technology companies in the coming financial year.

Second only to the Nifty Bank, the Nifty IT index has risen nearly 25% in the current financial year as Indian information technology companies latched on to a recovery in demand aided by their digital prowess.

Though gains in sector bellwethers Tata Consultancy Services and Infosys have been the sharpest at 30-40% on prospects of double-digit sales growth in the year, shares of other companies have gained at least 15-18% on an average. This compares to an over 14% rise in the Nifty 50.

Though the Nifty IT index did rise nearly 17% in 2017-18 as well, a strong performance for the third year in a row is a tall task, analysts said.

Of all the headwinds in store for technology players, the recent swerve in the rupee against the dollar is expected to be the most tenacious one.

The rupee, from a low of 74.48 in October, has bounced back to 69.20 a dollar as of today, even rising above the 69.00-a-dollar level to 68.34 a dollar on Mar 19. The Indian currency has fallen 6% in 2018-19.

Apart from boosting the overall earnings growth, the rupee's depreciation in the first three quarters of the year had improved the profitability of technology companies even when other factors that weighed on the margins were adverse.

"This is a year (2019-20) where the revenue momentum will remain good, but currency will decide the growth in EPS (earnings per share)," said an analyst with a leading domestic brokerage firm.

Though sales in rupee terms significantly outpaced that in dollar terms in 2018-19, the trend is expected to reverse this time.

The absence of a currency tailwind lowers the flexibility for companies to manage the rising fulfilment costs of sub-contractors and a wage hike, said Pankaj Kapoor of JM Financial Institutional Securities.

The low levels of unemployment in the US, at a time when the demand for technology services is high, has led to a crunch for skilled human resources, which in turn has led to higher costs of subcontracting.

Most technology companies took a hit of 50-100 basis points on their margins in the December quarter due to this higher cost, and expect the shortage of labour in the US to be met only over a couple of quarters.

Pick-up in hiring across the industry in the Apr-Dec period also means that companies will not only have to invest more in improving the skills of people, but also be relatively more liberal in wage hikes in order to retain people, Kapoor said.

Given that most companies have already taken steps such as hiring people at an entry level, and optimising the performance of employees on site and offshore, the options to prop margins from hereon will become more difficult.

Though analysts have not pegged a level for the rupee, they expect it to remain steady around the current levels on optimism over a strong mandate for the incumbent National Democratic Alliance government in the General Elections.

Apart from a stable rupee, a favourable outcome in the Lok Sabha polls is expected to veer investments in equities to companies that are linked to consumption, which will push sectors such as technology to the rear.

The Nifty IT index has, in fact, already underperformed the broader market in the first leg of the pre-election rally. The gauge of 10 technology companies has fallen 1% in contrast to the 7% gain in the Nifty 50.

Though analysts expect a 'catch-up' rally in the technology space after the outcome of the elections, these gains are unlikely to exceed those of the broader market.

TCS is among the top picks of money managers, but its high valuations are seen limiting buying in its shares from hereon.

Though domestic mutual funds have increased their ownership in TCS by 25 bps over the last three quarters till December, foreign institutional investors have reduced their ownership in TCS by 100 bps to 15.8%.

FII holding in Tech Mahindra and Infosys has remained largely stable in the three quarters as of December, while that in HCL Technologies has risen by nearly 200 bps.

Mutual funds, on the other hand, have increased their ownership in Tech Mahindra in a big way.

"Stocks have already factored in most positives…and at these valuations, the scope for multiple expansion remains limited," said an analyst with a bank-based retail brokerage.

Though the broader market seems on course for an election-induced, corporate earnings growth-led rally in 2019-20, the technology space is expected to simply trudge along.  End

IST, or Indian Standard Time, is five-and-a-half hours ahead of GMT

Edited by Mainak Moitra

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