Rupee Seen Failing to Help Lift Infosys Profit Margins

The rupee’s slide to a record low may fail to lift profit margins for India’s biggest software exporters as Infosys Ltd. and Tata Consultancy Services Ltd. pass on the currency benefit to clients in a race for orders.

India’s rupee has slumped 6 percent this quarter, making it the worst performer in Asia, and touched an all-time low of 58.985 a dollar on June 11. A weaker currency makes exports cheaper for overseas buyers, boosting demand. Still, Infosys shares fell 2.1 percent last week and Tata Consultancy tumbled 4.5 percent, the biggest declines since the five-day period ended April 26.

Profit margin at Tata Consultancy, the nation’s No. 1 software maker, has shrunk in six of the past nine quarters, while the gauge for Infosys has narrowed in the last two amid spending cuts by customers in North America and Europe. Sales recovery at Infosys may be painful and may take at least 36 months, Chairman N.R. Narayana Murthy said on June 15. While a weaker rupee may help increase revenue from existing contracts, prospective customers may negotiate cheaper rates, countering any gains, said Hitesh Shah, an analyst at IDFC Securities Ltd.

“This is what we saw the last time too, when the rupee plunged,” Mumbai-based Shah said in a telephone interview. “Neither Infosys nor TCS could improve their margins despite the rupee depreciation. To win deals, they will explore all possible ways.”

Profit Margin

In the three months through June 2012, when the currency had tumbled almost 9 percent against the dollar, the profit margin for Tata stayed little changed from the previous quarter, while for Infosys, it slipped to 23.8 percent from 26.16 percent, according to data compiled by Bloomberg.

Bangalore-based Infosys’ shares rose 1.2 percent to 2,422.60 rupees in Mumbai today, extending this year’s advance to 4.5 percent. Tata Consultancy has risen 16 percent in 2013 to 1,452.45 rupees, while the benchmark S&P BSE Sensex has declined 0.5 percent in the same period, according to data compiled by Bloomberg.

Every 1 percentage point swing in the rupee moves Infosys’ operating margin by 40 basis points, or 0.4 percentage point, V. Balakrishnan, a member of the board and former chief financial officer said in an e-mailed response. Tata Consultancy spokeswoman Harsha Ramachandra said the company doesn’t comment on the impact of currency fluctuations.

Order Slowdown

Indian computer-services companies, which typically depend on North America for 60 percent of their revenue and Europe for 25 percent, are struggling to win orders as spending slowed down after the financial crisis that started in 2008. The combined value of contracts in the two regions tumbled 28 percent to $18.7 billion in 2012 from four years earlier, according to a report by Bloomberg Industries.

Orders worth at least $1 billion, seen by the industry as a benchmark for success, dropped to as few as 5 last year, from 22 in 2010, the data show. Worldwide spending on information technology is projected to increase 4.2 percent to $3.7 trillion in 2013, according to a study by Gartner Inc.

Both Tata Consultancy and Infosys said this quarter that they have a “strong pipeline” of deals, with the latter forecasting a 6 percent to 10 percent increase in revenue for the financial year ending March 31, lagging behind the 10 percent to 14 percent estimate given by the industry group NASSCOM. Tata doesn’t provide sales forecasts.

Tougher Rules

The two companies are also battling the potential approval of legislation in the U.S. that would discourage outsourcing of technology jobs using H-1B visas by barring the program’s heaviest users from obtaining permits and raising fees.

If enacted, the law could prompt Indian software makers to hire local workers in the U.S. at higher wages, said Urmil Shah, an analyst with Kim Eng Securities Ltd. in Mumbai.

“The biggest worry to these companies is the immigration bill, which is going to make it more expensive for Indian companies to send workers to the U.S.,” Shah said. “Infosys and TCS may find it cheaper to re-invest any currency incentive back into the U.S. by hiring locally instead of paying for expensive visas.”

While a weaker rupee will help the companies win contracts overseas, the volatility in the currency always poses a challenge to their hedging strategy, said Walter Rossini, who manages $200 million of Indian market funds at Milan-based Aletti Gestielle Agr SpA.

Rupee Volatility

The rupee’s one-month implied volatility rose 171 basis points, or 1.71 percentage point this month. It touched 11.62 percent on June 11, the highest level since July 2012, indicating a greater risk of exchange-rate swings impacting profits.

“Volatility is always a problem,” Rossini said on the phone. “A good management team can plan in some way the important part of the income. They are accustomed to doing this.”

Infosys, which became the first Indian company to list on the Nasdaq stock exchange, brought back its co-founder N.R. Narayana Murthy, 66, this month as its chairman to steer the software maker through tougher visa rules and spending cuts in the U.S., its biggest market.

He told shareholders in Bangalore on June 15 that the software maker will adopt flexible pricing, refocus on winning large outsourcing deals and narrow the lead of its bigger rival Tata. Sales growth in the 12 months ending March 31 may be the slowest in four years, according to analyst estimates.

Software companies “can’t hang on to the conversion benefits this time around,” said Harit Shah, an analyst at Nirmal Bang Equities Ltd. in Mumbai. “They need to reinvest that money into markets like the U.S. and U.K. to win deals and maintain existing contracts. I don’t see an improvement in margins.”

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