Indian Outsourcing Stocks: Beware The Stronger Rupee

The ongoing strengthening of the Indian rupee against the dollar poses a threat to June quarter results for the Indian outsourcing stocks. The question is, how big is the risk?

Bear Stearns analyst Andrew Steinerman Tuesday morning notes that the rupee has appreciated 5% in the June quarter to date, more than was assumed in the guidance provided by most of the companies in the sector. He also notes that while some companies hedge their rupee exposure, not all of them do. And he also notes that while hedging impacts EPS, gains from hedges fall below the operating income line, and do not impact operating margins.

Steinerman says that Cognizant (CTSH) and Sapient (SAPE) do not appear to hedge their exposure; but that Infosys (INFY), Wipro (WIT) and Satyam (SAY) have “$100s of millions” of FX contracts and options.

Steinerman says that the quickest adjustment the companies can make would be to boost their utilization rates.

Steinerman says that Cognizant, which is based in New Jersey, not in India, is best positioned to handle the rupee risk, with “the fastest revenue growth and most defensible margins” in the group.

Steinerman provided the following chart on the impact to operating margins from a 1% rise in the rupee:

Infosys: trims operating margins 50 basis points.

Wipro: 35 basis points.

Satyam: 30 basis points.

Cognizant: 20 basis points.

Sapient: <15 basis points.

Accenture (ACN): <5 basis points.

Meanwhile, UBS analyst Trideep Bhattacharya asserts Tuesday that the impact of currency on these companies is over analyzed, and that the strength of demand is being under-estimated. By way of examples, Bhattacharya noted that EADS Group, parent of Airbus, is close to awarding a $600 million, 5-year contract for software development services to HCL Technologies,with TCS as a potential secondary vendor. Bhattacharya also says that Satyam has a deal with Nestle (NSRGY.PK) to increase its run-rate business to $25-30 million a year, from $10-$15 million.

Comments

[Dayanand Me...:]

Hi Eric,
Good point on strengthening of rupee. I feel even Cognizant will be equally impacted with this because even it has most of their employees in India who are paid in Indian rupees.

And as well all know Cognizant's maximum revenue comes in Dollars. So as rupee strengthens their revenue remains the same but the costs increase, becuase they have to spend more dollars to convest to rupees to pay their employees.

Following is a simple example :

Let us say Cognizant has a project where they are expecting $1mn revenues each quarter. 40 people are working in India in this project.Avg pay for an employee in this project is Rs25,000 / month which is Rs 75,000 / quarter.

Therefore net pay for 40 people = Rs3mn / quarter.

If for first quarter 1USD = Rs 45.00 then the employee cost for that project for that quarter = $66,666 (Rs 3 mn / 45)

If in the second quarter 1USD = Rs40.00 then the employee cost for the project that quarter = $75,000

This is an increase in $8,344 which is a whopping 12% increase.

CONCLUSION : The impact of gain in rupee is not dependent as to where the company is headquarterd instead it depends on its headcount in India. In fact I dont see how Accenture wont be impacted because it is projecting to have around 50,000 people in India by the end of this year.

Thanks,
Dayanand
visit me @ annualreportanalysis.b...

2007 Jun 27 09:32 AM

[sacsharma:]

And also one has to take into account rising salaries in Indian IT sector. I personally know how Accenture had to increase salary of many of its employees because of higher attrition rates.
Come to Bangalore and you will find how Indian IT employee is the king these days! In some domains, Indian IT salaries stand at only half the corresponding US salaries.
The only way out for IT companies might be to move up the value chain. The plain vanilla cost arbitrage might not work out that effectively.

2007 Jun 27 11:26 AM

[Market Insight:]

It is not just the Rupee appreciation that is going to impact Indian outsourcing firms.

There are other issues too:

1. Rising wages and salaries in India
2. Severe shortage of skilled talent
3. High staff turnover
4. Competition from the other countries notably - Philippines, some parts of Eastern Europe
5. Rising cost of office space
6. Lack of infrastructure - you need to see the mess that Bangalore airport is. Others are no better either.
7. Last but not the least - growing political pressure in the USA especially from a Demorcat controlled congress

2007 Jun 27 12:01 PM

[Thomas Victor:]

Eric,

Dayanand is correct, no way that CTSH is not going to be impacted by rising Indian wages. The key thing is where is the army of the software developers located?

My pick now is ACN.

All of my meagre investment money is in INFY and WIT. Otherwise I would now buy Accenture (ACN). Look at it's P/E ratio. I'm an Indian with a US MBA and currently working in a large California IT shop. I have experience of both the top US mgmt consultants and offshore software companies INFY, HCL &amp; Covansys. Our company has sporadically offshored to those three.

ACN is located at the top of the food chain in this situation. They already have the established elite top level US consultants. Their problem is to rapidly establish a high quality software factory in India, luring away stars from INFY, TCS etc. plus recruiting from campuses.

That seems easier for ACN to do than for, say INFY, to establish a Mgmt Consulting presence in the US, and EU. Similar to Mittal and Tata making deals with Arcelor and Corus who are higher up in the food chain maybe the Indian companies should buy out ACN

Thomas

2007 Jun 27 06:32 PM

[Dayanand Me...:]

Thomas,
Being in IT consulting industry I can exactly understand your point. You know what is the biggest USP of ACN stock......it is that even though they are the world's biggest outsourcing company, outsourcing is less than 50% of its total revenue.Becausue its consulting revenues is more than that of outsourcing.

2006 figures
Consulting revenues - $9.89 bn
outsourcing revenues -$6.75bn

So for any investor that wants to invest in outsourcing business and also want to play safe....there is just one stock.....u know what I am talking about...

2007 Jun 27 10:09 PM

[secretwisdom:]

Read this interesting news article:

Indian Rupee should go back to Rs 45/USD
diggindianews.com/Indi.../

2007 Jul 27 09:54 AM