Tuesday, October 13, 2009



Rupee appreciation to impact short-term performance of IT majors

The Indian Rupee has recently witnessed strong appreciation against the US Dollar. From nearly Rs 49 to a Dollar in September 2009, the currency has strengthened to Rs46.66, implying appreciation of nearly 5% in barely over a month's time and an over 10% rise from its lows of over Rs 52 to a Dollar in March 2009. We believe this is likely to negatively impact the near-term financial performance of these companies, even as 2QFY10 is likely to witness a decent performance on a strengthening of deal flows, with the global economic recovery coming to the fore and favourable results also in key vendor consolidation exercises like British Petroleum (BP) and Telstra. IT stocks have surged on the bourses, comfortably out-performing the Sensex over the past three months on expectations that the economic recovery and stronger deal flows will lead to earnings upgrades. It may be noted that the BSE IT Index had surged by as much as 39% in the September quarter, comfortably out-performing the Sensex, which gained 18%.

Apart from the movement in the Rupee-Dollar equation, it should also be noted that of late, cross-currency movements have been favourable for IT companies, with the US Dollar depreciating against the Euro, British Pound and Australian Dollar, leading to the value of these billings in US Dollar terms rising to that extent. Going forward, it is likely that this tailwind, which has been favourable over the past two quarters, could dissipate, thus leading to a 'double-whammy' of sorts, with no further favourable cross-currency swings, as also Rupee appreciation.

Consequently, with the steep stock price run-up, which has led to these stocks getting overheated and the recent Rupee strength, a correction has been witnessed, with Infosys, TCS and Wipro all witnessing falls after the recent strength. We believe that while the recent rise in the Rupee is likely to put pressure on near-term earnings, particularly 3QFY10 financial performance, we believe any correction in these stocks should be used as an opportunity to accumulate them. We expect 2QFY10 to be a strong quarter for Indian IT companies and expect an upgrade in guidance from Infosys on Friday, October 9, 2009. This is likely to be an indication of further economic recovery and the next few quarters could witness a return to growth, which we believe is the most critical factor for these companies to sustain their premium valuations.

We expect these companies to be able to manage Rupee appreciation to the extent that it is gradual, and not sudden and volatile and expect a recovery in core business to more-than-compensate for this headwind. We are positive on the Indian IT sector and believe a correction in these stocks is a good opportunity to add them to the portfolio.

Revenues for the quarter are expected to be lower by 15.3 % to Rs 2.8 bn in 2Q FY 10. The current de-stocking is expected to see revenue uptake expected in October -November 2009. However, we expect turnaround to happen from 3Q FY 10 onwards. OPM is expected to be at 36.9% compared to 48.2% in the corresponding period last quarter on account of lower revenues and current overheads. Profits for the year are expected to be at Rs. 849 mn down by 43.5% YoY in 2Q FY 10. We expect marginal forex gains of Rs 2.1 mn during Q2 FY 10. The reported net profit is expected to be of Rs 851 mn in Q2 FY 10.

The company is getting more qualification approvals for its Nutraceutical plant which is a positive sign for the company. Currently the stock is quoting at 18.6x FY 2010E and 16.4x FY 2011E. With better revenue traction expected in H2 FY10, we remain upbeat on the company and rate the stock as Outperformer with a price target of Rs 630 based on 19x FY 2011E.

To see full report: EQUITY RESEARCH