Indian Outsourcers May Be Hurt By Stronger Rupee

Indian outsourcing stocks could be vulnerable to recent strengthening of the Indian rupee against the U.S. dollar, Jefferies analyst Jospeh Vafi asserts in a research report this morning.

Vafi notes that the buck has depreciated 3% against the rupee since peaking in July, with 2% depreciation so far in the fourth quarter. “With many offshore names trading at 12-month high valuations,” he writes, “less earnings upside in Q4 due to a strengthening rupee could cause some shorter-term multiple contraction.”

Vafi says business remains strong at the outsourcing companies, but that “some of the upside experienced by ossrhore players last quarter due to a weakening rupee could reverse if the rupee continues to strengthen.” He notes that about 30% of overall costs for the offshoring companies are denominated in rupees.

In the longer term, he adds, continued appreciation of the rupee “could fundamentally impact the wage arbitage equation for offshore players as dollar denominated costs would rise.” He notes that most revenue for the offshoring companies are denominated in dollars or Euros, while significant costs are in rupees.

Vafi calculates that Infosys (INFY) sees a 30-40 basis point reduction in operating margins for every 1% rise in the rupee. For Cognizant (CTSH), he calclulate that a 1% rupee appreciation custs operating margins by 20-25 basis points, with similar sensitivity for Patni (PTI) and Syntel (SYNT).