IN THESE KINDS OF COMPANIES WE NEED TO SEE THE PERFORMANCE NOT ON Q-o-Q BASIS BUT ON SEQUENTIAL BASIS.]
Stocks of some IT companies appear to be rock-solid amidst the market volatility of the past few weeks. The S&P BSE IT index has returned 9.6% in a month compared with the Sensex's 5.7% fall and a drop of 4-8% in the indices of defensive sectors such as healthcare and FMCG.
A large revenue exposure to the North American market, which has been showing signs of revival, and rupee's fall are among the positive triggers for Indian IT exporters. Given these factors, the sector is well in a position to beat the benchmark returns in the near-term.
The growth in the domestic economy has been slowing for the past few quarters following slack in consumer and industrial demands and sluggish capital expenditure. It slowed down to a decade low of 5% in FY13. In addition, some of the research agencies have cut the forecast for FY14 to 6% from 6.5% reflecting an uncertainty over an economic rebound anytime soon.
US revival, weak rupee keep IT safe from raging storm Against the backdrop, what works well and rather too well for the Indian IT sector is the fact that its exposure to the domestic economy is perhaps the lowest when compared with other sectors. In FY13, the sector earned just over 18.5% of revenue from domestic operations. Which means, every four out of five rupees of revenues comes from overseas.
Thus, talks of revival in the US economy augurs well for Indian IT exporters. On the flip side, the stance of the US government on labour migration and the proportion of local jobs created by Indian IT players would have a bearing on the performance of Indian IT players.
A possible fallout is that Indian companies will have to increase their American workforce, which will impact operating profitability. At the moment, Indian IT players have less than 10% non-Indian workforce. A steeper fall in the rupee against major currencies is another revenue-booster for IT exporters.
What helps is the fact that the majority of the operating cost is denominated in rupees. For instance, 48% of the expenses of TCS were on Indian employees in FY13.
For IT exporters, 1% depreciation in the rupee against the dollar tends to add over 30 basis points to operating margin on an average. The exact benefit, however, depends upon the cash flow hedging practices of companies including the rate at which currency forward contracts are booked and the proportion of contracts that mature every quarter.
A business model, where the majority of revenue is in foreign currencies while a larger proportion of expenses is in domestic currency, helps Indian companies.
Given the pressure on current account balance and declining productivity in the economy, the rupee is expected to remain weak at least in the near-term. While this spells doom for import-heavy, export-light companies in manufacturing and infrastructure, it's a positive trigger for export-driven sectors with negligible imports such as IT.
A lesser reliance on debt financing is another plus point. Moreover, IT stocks are expected to enjoy rich valuations in the near-term amidst a lack of a better investment alternatives.