Rising Dollar Spells Trouble for TCS, Other IT Firms
IT stocks underperformed the broader Sensex and Nifty on Wednesday, but even from a medium-term perspective, they have not been high on the shopping list of investors.
The IT sub-index on the BSE is up 3.3 per cent and 6.5 per cent over one and three- month period as compared to a 2.5 per cent and 5 per cent gain in the Nifty during the same time. The true extent of underperformance in IT stocks can be gauged if their performance is compared to cyclical stocks. The Bank Nifty, for example, has gained 9 per cent and 16 per cent over one and three-month period.
Analysts say there's little hope that IT stocks would be back in demand any time soon. Here's why:
1) Global currencies such as the pound, euro and Australian dollar, which contribute between 25-30 per cent of tier-1 IT revenues, have depreciated by nearly 4-6 per cent sequentially in the third quarter, Nomura says. That means Indian companies' revenues from European operations could be flat to negative in the December quarter. Nomura expects overall US dollar revenue growth to come down by an average 150 basis points for India's top five IT companies in the December quarter.
2) Companies that have high exposure to Europe and Japan will be worst hit. Nomura says both TCS and Tech Mahindra come in this category as they have the lowest US dollar revenue proportions (52-54 per cent) of overall revenues. Japan's yen depreciated 10 per cent in the September quarter.
3) The rupee has depreciated against the dollar, but it has fallen less than other global currencies. So, the rupee has gained against other currencies. These two contrasting movements will largely negate each other, leading to no material impact on rupee revenues on a sequential basis, Nomura says.
4) The December quarter is seasonally weak because of holidays in the key markets of North America and Europe. This will further weigh on revenue growth in the current quarter.
5) Cyclicals, such as banks and autos, have outperformed on hopes of a turnaround in the Indian economy. However, the fate of IT companies is linked to the global economy. While the US economy seems to be on the mend, Europe remains a problem area. This is bad news for IT firms as discretionary spending will be under pressure and weigh on margins.
Both foreign and domestic investors are underweight on the IT sector. In fact, software has reached an all-time high underweight for foreign institutional investors (FIIs) at a time when foreign ownership in Indian stock markets is at an all-time high, according to a Bank of America Merrill Lynch report.
"All the three large software companies (Infosys, TCS and Wipro) are among the top-10 underweight stocks for the FIIs," BofA-ML report says.
