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Sharp INR/USD depreciation of 11% since 30 Jun-11 could add 4-6% to our FY12 EPS
forecasts for Indian IT large caps. This would help mitigate some of demand headwinds from
recent macro environment. Amongst large caps, we expect Infosys and HCL Tech to gain
relatively more from currency.
Currency to help mitigate some of the macro headwinds
Sharp INR/USD depreciation of 10.6% since 1QFY12 end could result in an upside
potential of 4-6% for FY12 and 10-15% for FY13 on an average under various scenarios
of INR/USD assumptions (please refer to table below) for the Indian IT large caps stocks.
However we believe that this upside potential through currency gains, if any, are more
visible for FY12 rather than FY13 given the volatile nature of currency, which defies
prediction too far into the future. However the cross currency impact could marginally
lower the gains from rupee depreciation.
Post the 2008-09 slowdown and high currency volatility during that time, most companies
have now learned to have a reasonable hedge position using simple hedges versus
taking any medium-long term call on currency with various combinations of exotic hedge
positions. Therefore, we believe that the sensitivity of currency gains to be better this
time versus last slowdown post hedge impact.
Amongst large caps we expect Infosys and HCL Tech are likely to gain the most given
their relatively low hedge positions. While we expect TCS/Wipro to gain lower given
higher hedge position.
We do not believe that INR depreciation is structural positive on any valuation re-rating on a
sustainable basis given its volatile nature. However it may help to curtail the earnings
pressure during times of macro headwinds on demand and may provide some downside
support.
Notably in last macro slowdown, the BSE IT index has performed largely in line with BSE
Sensex during April 2008-March 2009 during a period of sharp INR/USD depreciation of 30%
and also the severe macro headwinds during which some of the clients of Indian IT were
directly impacted. However amongst large caps only Infosys which outperformed the Sensex
by 23% while TCS and Wipro underperformed by 5-6% and HCL Tech underperformed by
16% during the same period.
Infosys and HCL Tech are better place to gain from currency
Amongst peers, given the low hedge positions of Infosys and HCL Tech (equivalent to 2-3
months of net inflow), we expect currency gains to be higher for Infosys and HCL Tech versus
TCS/Wipro.
As we highlighted in our recently released flash note on TCS ("High forex gains may not
continue" dated 21st September 2011), TCS has around US$1.7bn worth of outstanding
revenue hedges (with US$1.1bn maturing in 2QFY12 and balance beyond FY12), equivalent
to 3-4 months of net inflow. Notably most of the hedges due in 2QFY12 are maturing in later
part of 2QFY12 wherein Indian rupee started depreciating versus USD sharply. Besides the
above, TCS also has around US$1.5bn worth of non-designated hedges at the end of
1QFY12 which could result into balance sheet translation gain getting minimised with likely
MTM (mark to market) losses on non-designated hedges in 2QFY12.
Secondly, TCS is almost fully hedged for 3QFY12 with average strike rate of Rs46.5 versus
current spot rate of around Rs48. Therefore if current spot rate continues in 3QFY12, we
expect material impact on forex income even in 3QFY12 for TCS.
In case of Wipro, despite higher outstanding hedges, maturity of the hedge cover is spanning
from 2-4 quarters to around 2 years which will reduce the impact, if any, in immediate
quarters. However, we await more clarity from management regarding this.
Losses for HCL Tech through translation of foreign currency loan are likely to be more than
offset by translation gain from net monetary assets (primarily receivables) in foreign currency.
Amongst mid caps, Tech Mahindra, Hexaware and Polaris have significant hedge positions,
though at a relatively better rate (ranging Rs48-49).
Our View
We continue to remain cautiously optimistic on the sector as we believe that sector is better
poised than last slowdown given no major excesses on billing rates and IT spend by clients
post 2008-09 slowdown, expected pricing discipline amongst vendors going forward and
better health of US corporates' balance sheet.
In this state of increased macro uncertainty, we prefer stocks with relatively low valuations,
more revenue diversity and higher flexibility in managing margins. Infosys, HCL Tech and
Wipro are our top large-cap picks. Polaris is our top mid-cap pick.
Stock correction resulting from further macro news flow is possible, but over the medium to
longer term we expect valuation multiples to improve given a likely rebound in earnings
growth from 2HCY12
Any sharp deterioration in the macro environment in the US and Europe is a key risk.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Sharp INR/USD depreciation of 11% since 30 Jun-11 could add 4-6% to our FY12 EPS
forecasts for Indian IT large caps. This would help mitigate some of demand headwinds from
recent macro environment. Amongst large caps, we expect Infosys and HCL Tech to gain
relatively more from currency.
Currency to help mitigate some of the macro headwinds
Sharp INR/USD depreciation of 10.6% since 1QFY12 end could result in an upside
potential of 4-6% for FY12 and 10-15% for FY13 on an average under various scenarios
of INR/USD assumptions (please refer to table below) for the Indian IT large caps stocks.
However we believe that this upside potential through currency gains, if any, are more
visible for FY12 rather than FY13 given the volatile nature of currency, which defies
prediction too far into the future. However the cross currency impact could marginally
lower the gains from rupee depreciation.
Post the 2008-09 slowdown and high currency volatility during that time, most companies
have now learned to have a reasonable hedge position using simple hedges versus
taking any medium-long term call on currency with various combinations of exotic hedge
positions. Therefore, we believe that the sensitivity of currency gains to be better this
time versus last slowdown post hedge impact.
Amongst large caps we expect Infosys and HCL Tech are likely to gain the most given
their relatively low hedge positions. While we expect TCS/Wipro to gain lower given
higher hedge position.
We do not believe that INR depreciation is structural positive on any valuation re-rating on a
sustainable basis given its volatile nature. However it may help to curtail the earnings
pressure during times of macro headwinds on demand and may provide some downside
support.
Notably in last macro slowdown, the BSE IT index has performed largely in line with BSE
Sensex during April 2008-March 2009 during a period of sharp INR/USD depreciation of 30%
and also the severe macro headwinds during which some of the clients of Indian IT were
directly impacted. However amongst large caps only Infosys which outperformed the Sensex
by 23% while TCS and Wipro underperformed by 5-6% and HCL Tech underperformed by
16% during the same period.
Infosys and HCL Tech are better place to gain from currency
Amongst peers, given the low hedge positions of Infosys and HCL Tech (equivalent to 2-3
months of net inflow), we expect currency gains to be higher for Infosys and HCL Tech versus
TCS/Wipro.
As we highlighted in our recently released flash note on TCS ("High forex gains may not
continue" dated 21st September 2011), TCS has around US$1.7bn worth of outstanding
revenue hedges (with US$1.1bn maturing in 2QFY12 and balance beyond FY12), equivalent
to 3-4 months of net inflow. Notably most of the hedges due in 2QFY12 are maturing in later
part of 2QFY12 wherein Indian rupee started depreciating versus USD sharply. Besides the
above, TCS also has around US$1.5bn worth of non-designated hedges at the end of
1QFY12 which could result into balance sheet translation gain getting minimised with likely
MTM (mark to market) losses on non-designated hedges in 2QFY12.
Secondly, TCS is almost fully hedged for 3QFY12 with average strike rate of Rs46.5 versus
current spot rate of around Rs48. Therefore if current spot rate continues in 3QFY12, we
expect material impact on forex income even in 3QFY12 for TCS.
In case of Wipro, despite higher outstanding hedges, maturity of the hedge cover is spanning
from 2-4 quarters to around 2 years which will reduce the impact, if any, in immediate
quarters. However, we await more clarity from management regarding this.
Losses for HCL Tech through translation of foreign currency loan are likely to be more than
offset by translation gain from net monetary assets (primarily receivables) in foreign currency.
Amongst mid caps, Tech Mahindra, Hexaware and Polaris have significant hedge positions,
though at a relatively better rate (ranging Rs48-49).
Our View
We continue to remain cautiously optimistic on the sector as we believe that sector is better
poised than last slowdown given no major excesses on billing rates and IT spend by clients
post 2008-09 slowdown, expected pricing discipline amongst vendors going forward and
better health of US corporates' balance sheet.
In this state of increased macro uncertainty, we prefer stocks with relatively low valuations,
more revenue diversity and higher flexibility in managing margins. Infosys, HCL Tech and
Wipro are our top large-cap picks. Polaris is our top mid-cap pick.
Stock correction resulting from further macro news flow is possible, but over the medium to
longer term we expect valuation multiples to improve given a likely rebound in earnings
growth from 2HCY12
Any sharp deterioration in the macro environment in the US and Europe is a key risk.
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