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India Equity Research Reports, IPO and Stock News
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Technology
India
Rupee at 50. Re/US$ sustaining at the current depreciated levels would provide
substantial hedge against earnings pressure from (1) potential negative surprises on
volumes and/or pricing front, and (2) adverse cross-currency movements. Weak Rupee
presents meaningful margin buffer which the Indian IT companies could utilize to
protect volume growth (at the expense of pricing) in case of a significant volume
slowdown (not our base case, but a possibility). This, and the variable cost control a
slow growth environment provides, should prevent further EPS downgrades.
Weak Rupee, if it sustains, provides substantial margin and earnings buffer
Even as we are not arguing for a buy case on Indian IT services stocks based on Re/US$ movement
over the past few weeks, we believe it is important to appreciate the margin/earnings buffer a
weak Rupee provides should US$ revenue growth (volume and/or pricing) or cross-currency levels
(GBP, EUR, AUD) surprise on the downside. We note that European currencies as well as AUD have
also been depreciating versus the US$ recently; this impacts US$ revenue growth adversely. Tier-I
Indian IT companies have 20-30% of their revenues denominated in non-US$ currencies.
Every percent depreciation in the Rupee provides a 30-40 bps EBITDA margin uplift and
1.5-3% EPS uplift (unhedged)/ 1-2.5% EPS uplift (adjusted for hedging losses). We present
the FY2012E/13E EPS sensitivity of IT names in our coverage universe to movements in Re/US$
levels (see Exhibit 1). We note that we have adjusted for hedging losses assuming hedge levels (as
% of receivables) remain constant for various companies at June 2011 levels. Change in hedging
strategy and timing of fresh hedges could drive variation from our estimates, albeit not meaningful.
Quick lookback – Re depreciation helped mitigate margin pressure in the previous cycle
Exhibit 3 depicts our assessment of key drivers of Infosys’ margin movement from FY2008-FY2011
(a full downturn-uptick cycle on demand). Rupee, which depreciated nearly 14% to average 45.5
for FY2011 from FY2008 average levels of 40, contributed almost 550 bps to Infosys’ OPM in this
timeframe. This helped mitigate nearly 370 bps pressure from pricing decline and almost 500 bps
of pressure from wage inflation in this period.
We remain positive; levels attractive to enter select names from a medium-term perspective
We believe select Indian IT names are approaching levels (we are possibly 10-15% away) where an
uncertain macro environment is being extrapolated into a severe, sharp, and permanent loss of
earnings growth power of these companies. Business model, and consequently, earnings power of
these companies based upon market share gains for IT offshoring remains intact, in our view. Post
recent macro developments, we are headed into an uncertain environment and we do not know
how FY2013E would pan out – our estimates depict our current view on a highly uncertain
2HFY12E/ FY2013E; there could be downside risks. Nonetheless, the key is to appreciate the
risk/reward at current levels – this appears favorable to us. We see the recent correction as an
opportunity to BUY into the long-term secular market share gain story for IT offshoring through
high-quality names. TCS and Infosys are our top picks. Of course, in the current market scenario
where sentiments are broadly negative, it would be foolhardy to call the bottom – this remains a
near-term risk to our positive thesis on select names.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Technology
India
Rupee at 50. Re/US$ sustaining at the current depreciated levels would provide
substantial hedge against earnings pressure from (1) potential negative surprises on
volumes and/or pricing front, and (2) adverse cross-currency movements. Weak Rupee
presents meaningful margin buffer which the Indian IT companies could utilize to
protect volume growth (at the expense of pricing) in case of a significant volume
slowdown (not our base case, but a possibility). This, and the variable cost control a
slow growth environment provides, should prevent further EPS downgrades.
Weak Rupee, if it sustains, provides substantial margin and earnings buffer
Even as we are not arguing for a buy case on Indian IT services stocks based on Re/US$ movement
over the past few weeks, we believe it is important to appreciate the margin/earnings buffer a
weak Rupee provides should US$ revenue growth (volume and/or pricing) or cross-currency levels
(GBP, EUR, AUD) surprise on the downside. We note that European currencies as well as AUD have
also been depreciating versus the US$ recently; this impacts US$ revenue growth adversely. Tier-I
Indian IT companies have 20-30% of their revenues denominated in non-US$ currencies.
Every percent depreciation in the Rupee provides a 30-40 bps EBITDA margin uplift and
1.5-3% EPS uplift (unhedged)/ 1-2.5% EPS uplift (adjusted for hedging losses). We present
the FY2012E/13E EPS sensitivity of IT names in our coverage universe to movements in Re/US$
levels (see Exhibit 1). We note that we have adjusted for hedging losses assuming hedge levels (as
% of receivables) remain constant for various companies at June 2011 levels. Change in hedging
strategy and timing of fresh hedges could drive variation from our estimates, albeit not meaningful.
Quick lookback – Re depreciation helped mitigate margin pressure in the previous cycle
Exhibit 3 depicts our assessment of key drivers of Infosys’ margin movement from FY2008-FY2011
(a full downturn-uptick cycle on demand). Rupee, which depreciated nearly 14% to average 45.5
for FY2011 from FY2008 average levels of 40, contributed almost 550 bps to Infosys’ OPM in this
timeframe. This helped mitigate nearly 370 bps pressure from pricing decline and almost 500 bps
of pressure from wage inflation in this period.
We remain positive; levels attractive to enter select names from a medium-term perspective
We believe select Indian IT names are approaching levels (we are possibly 10-15% away) where an
uncertain macro environment is being extrapolated into a severe, sharp, and permanent loss of
earnings growth power of these companies. Business model, and consequently, earnings power of
these companies based upon market share gains for IT offshoring remains intact, in our view. Post
recent macro developments, we are headed into an uncertain environment and we do not know
how FY2013E would pan out – our estimates depict our current view on a highly uncertain
2HFY12E/ FY2013E; there could be downside risks. Nonetheless, the key is to appreciate the
risk/reward at current levels – this appears favorable to us. We see the recent correction as an
opportunity to BUY into the long-term secular market share gain story for IT offshoring through
high-quality names. TCS and Infosys are our top picks. Of course, in the current market scenario
where sentiments are broadly negative, it would be foolhardy to call the bottom – this remains a
near-term risk to our positive thesis on select names.
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