IT and pharma companies that have a large portion of revenues unhedged will benefit the most.
Whenever the rupee slips against the dollar, market experts often come up with a simple solution — line your portfolio with the stocks of exporters.
But while the listed universe features a long list of export-driven sectors — textiles, diamond and jewellery, chemicals — quality companies who earn foreign exchange are mostly from the software or pharma space.
But not all software companies or pharma majors will reap big gains from a weak rupee. Here’s how you can choose.
Pharma stocks first. Even as many other sectors struggled in 2012-13, pharma companies clocked healthy double-digit growth. Over half the annual revenues for the pharma industry come from exports. Impending patent expiries of drugs worth over $33 billion in the US over the next two years will remain a key export growth driver for Indian companies.
This suggests that progressive weakness in the rupee, which lost over 10 per cent against the dollar since April 2013, should theoretically benefit pharma companies with significant dollar earnings.
But in practice, pharma companies will not reap full benefits from the recent rupee depreciation because they ‘hedge’ their revenues or cash flows, by locking into a fixed exchange rate for a portion of their revenues.
Given this backdrop, the companies who will benefit the most from the weak rupee will be those that have left a large portion of revenues unhedged or locked into high dollar-rupee rates.
Pharma hits and misses
So who are the likely beneficiaries? Going by their hedging strategies, pharma majors such as Sun Pharma, Lupin and Cipla appear likely candidates.
To illustrate, Sun Pharma had forward contracts worth $330 million outstanding as on March 31, 2012, its previous balance sheet date.
This was less than a third of the company’s dollar revenues in 2012-13. Hedging a lower proportion of its future cash flows helped Sun Pharma capitalise on a weak rupee last fiscal. Sun Pharma and Cipla have seen meaningful benefit from a falling rupee over the last four quarters.
But a weak rupee did not help the performance of companies such as Ranbaxy and Dr Reddys’ Labs because of cash flow hedges at lower exchange rates. For Glenmark, a high dollar outflow towards costs and interest payments has tended to offset benefits from a weaker rupee in the past.
For Zydus Cadila, again, the rupee may yield limited benefits because apart from hedges on future cash flows, it has foreign currency loans payable in dollars.
Capped gains for IT
Domestic IT companies are likely to be significant beneficiaries of the rupee’s slide below Rs 59 levels to the dollar. But wage hikes and cross-currency movements could reduce the extent of gains.
In general, a one per cent decline in the rupee against the US dollar helps Indian software companies improve operating margins by 30-50 basis points.
With the rupee depreciating by over 10 per cent during April-June, IT companies may expect improvements in the range of 200-250 basis points.
But with companies hedging a portion of their dollar inflows, at rates that are not attractive, the full benefit may not accrue. Companies may incur forex losses on hedged contracts.
Companies such as TCS, Infosys, Wipro and HCL have hedged 15-33 per cent of their estimated revenues. These software players derive 52-63 per cent of their revenues from North America. Hedging is generally for a period of one year for most players, barring some such as Infosys that take hedges for just two quarters. Most of these contracts are at Rs 53-54 a dollar, suggesting that rupee weakness beyond this level will not flow through to these companies immediately.
Mid-tier IT companies such as MindTree, Hexaware and NIIT Technologies are likely to see improvement in operating margins as these companies derive a higher proportion of their revenues from North America than their large-sized peers.
Apart from the rupee, the other key currencies such as the British pound, the euro and the Australian dollar have depreciated by 1-3 per cent against the dollar, which means that large software players could see about 50-75 basis points taken off from the operating margins.
In the near term, with most companies announcing wage hikes of 6-8 per cent, there is likely to be some erosion in margins on this count too. The key factors that will be monitored will once again be revenue growth in dollar terms and volume expansion for all IT companies.
The best bets on both these counts would be TCS and HCL Technologies for the foreseeable future.
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