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Currency intrigue
INR depreciation is driving some optimism on IT stocks despite a
worsening macro and mixed demand commentary from Tier-1 vendors.
The ~7.8% depreciation in INR against US$ over last 45 days and
expectation of further depreciation in light of continued global risk
aversion have raised hopes of earnings upgrades. While benefits from a
weaker currency will undoubtedly flow through in near-term financials,
historical experience shows that IT stocks seldom perform in a
depreciating currency environment. In our view, core business growth ($-
revenues) will continue to dominate the investment thesis within Indian
techs and we see downside risks there. Stay cautious on Indian IT sector.
How did the currency move impact stock performance in 2008?
q INR depreciated ~24% c.f. US$ through 2008. Despite huge margin benefits from
this massive move, most IT stocks underperformed the broader Indian market.
q While the benefit to margins from the currency move was somewhat overshadowed
by forex losses, the key driver of absolute stock downsides was a deteriorating
revenue outlook which pulled down valuations significantly.
q Infosys was the only stock to buck the trend outperforming the Indian market but
even Infosys fell ~35% through CY2008.
Currency set-up for 2011 is slightly different c.f. 2008
q While it is tough to take currency calls, extent of depreciation seems unlikely to be
as big as 2008 limiting margin benefits. Balancing that is the lower quantum of
hedges as proportion of revenues c.f. 2008 which should help contain forex losses.
q The INR depreciation will undoubtedly aid margin performance (1% depreciation
gives ~30-40bps margin benefit), the investment thesis in IT is being driven more
by FY13 revenue growth expectations, where risk remains on the downside.
q A depreciating INR is also reflective of the increasing global risk aversion as well.
This combined with the risk to revenue growth will limit valuation multiples
restraining stock up-moves in the Indian tech sector.
Core business outlook continues to hold the key
q 1HCY07 is the only period where stock performance was influenced by currency
moves more than business fundamentals.
q While a weaker currency is a positive for earnings, we believe that improvement in
core business outlook needs to precede any outperformance going ahead.
q Business fundamentals have progressively worsened over the last few months with
select vendors indicating delays in project starts and closure of deals.
q Past experience backs our thesis that Indian tech stocks do not
perform in a sharp currency depreciation environment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Currency intrigue
INR depreciation is driving some optimism on IT stocks despite a
worsening macro and mixed demand commentary from Tier-1 vendors.
The ~7.8% depreciation in INR against US$ over last 45 days and
expectation of further depreciation in light of continued global risk
aversion have raised hopes of earnings upgrades. While benefits from a
weaker currency will undoubtedly flow through in near-term financials,
historical experience shows that IT stocks seldom perform in a
depreciating currency environment. In our view, core business growth ($-
revenues) will continue to dominate the investment thesis within Indian
techs and we see downside risks there. Stay cautious on Indian IT sector.
How did the currency move impact stock performance in 2008?
q INR depreciated ~24% c.f. US$ through 2008. Despite huge margin benefits from
this massive move, most IT stocks underperformed the broader Indian market.
q While the benefit to margins from the currency move was somewhat overshadowed
by forex losses, the key driver of absolute stock downsides was a deteriorating
revenue outlook which pulled down valuations significantly.
q Infosys was the only stock to buck the trend outperforming the Indian market but
even Infosys fell ~35% through CY2008.
Currency set-up for 2011 is slightly different c.f. 2008
q While it is tough to take currency calls, extent of depreciation seems unlikely to be
as big as 2008 limiting margin benefits. Balancing that is the lower quantum of
hedges as proportion of revenues c.f. 2008 which should help contain forex losses.
q The INR depreciation will undoubtedly aid margin performance (1% depreciation
gives ~30-40bps margin benefit), the investment thesis in IT is being driven more
by FY13 revenue growth expectations, where risk remains on the downside.
q A depreciating INR is also reflective of the increasing global risk aversion as well.
This combined with the risk to revenue growth will limit valuation multiples
restraining stock up-moves in the Indian tech sector.
Core business outlook continues to hold the key
q 1HCY07 is the only period where stock performance was influenced by currency
moves more than business fundamentals.
q While a weaker currency is a positive for earnings, we believe that improvement in
core business outlook needs to precede any outperformance going ahead.
q Business fundamentals have progressively worsened over the last few months with
select vendors indicating delays in project starts and closure of deals.
q Past experience backs our thesis that Indian tech stocks do not
perform in a sharp currency depreciation environment.
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