Strong rupee puts revenues, margins of IT firms at risk

The software services sector has faced growth risks over a few years. New technologies and complex requirements of customers have made the going tough for Indian vendors. 

This year, information technology (IT) firms are expected to face another challenge — currency. the cross-currency movements are expected to hit both revenues and margins. 

To understand the challenge posed by currency, it is important to understand the revenue mix (in currency terms) of most software service providers.

According to analysts, Indian firms derive anywhere between 32 per cent and 49 per cent of their revenues from non-dollar currencies.

Over the past 12 months, the rupee has appreciated 17 per cent against the euro, 7.5 per cent against the British pound, and 13.5 per cent against the Australian dollar. 

As a thumb rule, for every one per cent move in a receivable currency, earnings before interest and tax (Ebit) margin gets impacted by 30 basis points (bps).

Kotak Institutional Equities says: “Appreciation of the rupee against non-dollar currencies presents 60-75 bps margin headwinds at spot rates in FY16. The general compensatory benefit of strength of dollar against other currencies is weakness in the rupee; so far, it has not played out.” 

The rupee has remained largely stable against the dollar over last year. The companies having a relatively higher exposure to non-dollar and non-domestic revenues include HCL Tech, Tech Mahindra, Wipro and Tata Consultancy Services and, therefore, face the bigger margin headwinds.

Emkay Global remains selectively positive on the sector, estimating 200-300 bps adverse impact on revenues and 50-100 bps impact on Ebit margins for FY16, if current exchange rates were assumed as stable for FY16. 

The margin headwinds, claim analysts, became visible in the December quarter itself. While Infosys reported a 60-bps improvement in margins sequentially, its European Ebit margin declined 90 bps.

The risk is higher for existing customers, which would have priced contracts either on fixed prices or on a time and material basis. While new deals might be priced at current rates, existing contracts would impact revenues and margins. 

Companies might find it difficult to change pricing by giving the currency argument, as these are multi-year deals.

Among other IT vendors, Wipro reported a sequential drop in margins. Tech Mahindra’s operating margins, too, disappointed analysts.

Experts, however, believe players such as HCL Tech are at greater risk due to their higher exposure to IT infrastructure management services (IMS) and Europe.

IMS deals are long- tenure, unlike application and maintenance deals, where the deal value is defined over a long period of time.