Mumbai: Earnings upgrades ahead of quarterly results are not commonplace. Especially for the Indian IT industry whose profitability has remained under pressure and faces questions about sustainability of a pickup in revenue growth rates.
Still, thanks to rupee depreciation, earnings estimates are seeing upward revisions, albeit marginally. So far this quarter (as of 16 September), Indian rupee has depreciated 1.4% against the US dollar compared to an average exchange rate in April-June this year.
Tracking the softness and benign outlook for Indian rupee, Kotak Institutional Equities raised its earnings estimates for IT companies under its coverage by up to 4%. “We bake in Kotak economist’s revised INR/USD rates of 71-74 from 70-72 earlier for FY2020-22E. Revised INR/USD estimates and cross-currency headwinds to revenue growth effectively result in 10-50 bps increase in EBIT margin assumptions and 0-4% increase in EPS estimates for FY2020-22E for various companies," analysts at Kotak Institutional Equities said in a note.
Rupee depreciation aids profit margins of IT companies. A 1% depreciation in the local currency against the US dollar aids IT companies’ earnings before interest and tax (Ebit) margin by 20-30 basis points (bps), pointed out the note from Kotak. 100 basis points equal one percentage point.
Of course the extent of benefits from the weakness in the local currency depends on the level of hedges. Tech Mahindra Ltd and L&T Infotech Ltd are said to have hedged a large part of their cash flows and are expected to see miniscule benefits. TCS Ltd, Infosys Ltd, and Mindtree Ltd on the other hand are estimated to see noticeable impact.
The benefits from currency depreciation, however, can be temporary at best. In a competitive business environment it is difficult to hold on to currency gains beyond a couple of quarters. As a study by analysts at Motilal Oswal Financial Services Ltd shows, a sharp depreciation in the Indian rupee notwithstanding, gross margins of large Indian IT companies have steadily declined over the last five fiscal.