Currency appr and its impact

UP, UP AND AWRY
Sandeep Singh
Posted online: Tuesday , July 31, 2007

MindTree Consulting, which made an impressionable debut on the bourses earlier this year, increased its revenues by 35 per cent in the first quarter (April to June) of 2007-08. Yet, its net profit for the same period dipped 15 per cent. In another industry, auto ancillaries, Sundaram Brake Linings saw both its revenue and profit growth slip in Q1. As did GTN Textiles in textiles.These three companies are not random examples of corporate performance. They represent three sectors that carry India’s aspirations as a low-cost, high-quality export hub — software, auto ancillaries and textiles — and the hopes of millions of investors who have backed them to make a mark on the global landscape. MindTree got 88 per cent of its revenues from exports in 2006-07, Sundaram Brake 33.3 per cent and GTN Textiles 81.1 per cent in 2005-06 .


Rupee lossesFrom a blessing, this export orientation has become a curse. In the past year, the rupee has appreciated 14.1 per cent against the dollar, from Rs 46.85 to Rs 40.27 now. For Indian exporters selling in dollars, it’s a straight notional loss. If they sold a good for $100 a year ago, they would have repatriated Rs 4,685 into India. Today, if they sell the same good at $100, they will bring back only Rs 4,027.For some like the frontline software companies, it’s a loss in margins. Says Rostow Ravanan, chief financial officer, MindTree Consulting: “Every 1 per cent rise in the rupee lowers our net margin by 0.5 percentage point.” Down the ranks, the threat is of losing business to low-cost export hubs like China.Worrying as the dip in performance is, the forecast for the rupee against the dollar is a greater cause for concern for exporters in general and those from these three sectors in particular. Big dollars are being pumped into India, through the FII and FDI route, by private equity players, in the form of foreign currency loans. Says Abheek Barua, chief economist, HDFC Bank: “The dollar should be Rs 38-39 by next year. Rupee appreciation is here to stay, for four to five years.” Adds Subir Gokarn, executive director and chief economist, Crisil: “In a balance of payments surplus situation, the natural tendency of a currency is to appreciate. If the RBI decides not to intervene, there is no telling where — Rs 39, 38 or 37 — it may go.”A rising rupee impacts your finances in many ways. If you are working abroad and earning in dollars, you will repatriate fewer rupees into India. Conversely, if you are travelling abroad, you will need fewer rupees to buy the dollars. However, those who are affected in such forms are far more than the investors of companies that make a major part of their sales in dollars.Some of them also import raw materials or spend in dollars, which covers the loss on the export side.However, if a company’s exports are high and imports low, as is the case with software, textiles and auto ancillaries, they have some reorientation to do.

Software
In terms of export share, software leads the pack. Several companies are only doing work for foreign companies, that too mostly in the US, and are being paid in dollars. For the top 10 IT companies by revenues, exports comprise an average of 83 per cent of their revenues.During the rupee’s 14 per cent rise against the dollar, the sharp rise has been since March — 9 per cent in five months. So, though the 2006-07 numbers are strong, those for Q1 2007-08 show some after-effects. The big four — TCS, Infosys, Wipro and Satyam — have seen growth, both in revenues and net profit, in Q1 fall compared to 2006-07. For instance, after several successive quarters of above 25 per cent profit growth, Wipro’s year-on-year profit growth dropped to 8.4 per cent.However, experts say, the nature of the software business is such that Indian companies won’t lose out overnight. Says Gokarn: “Software is knowledge-intensive and not easy to substitute, as clients tend to stick with their partners.” Conversely, if business does shift to neighbouring low-cost countries like The Philippines, it might not come back easily.For now, the possibility of a shift is remote. Says Ravanan: “Software is profitable, its demand potential is huge, and it will find ways to recalibrate.”The biggies have room to play with and they are seeing robust demand for their services. Companies down the ranks will feel the pinch more, as they have less room to manoeuvre. Says an IT analyst: “The impact will be more on mid-sized and smaller players. Large companies have the flexibility to absorb the impact. Some of them even have pricing power to pass on the rupee appreciation to their clients.” The three biggies — TCS, Infosys and Wipro — are still good long-term picks.

TextilesUnlike software, the textile business is neither knowledge-intensive nor do companies in it operate at the top end of margins. Admits Rajendra J. Hinduja, executive director, finance and administration, Gokaldas Exports: “Net margin of apparel companies is 5-9 per cent. If the dollar takes away 8 percentage points, we are in trouble.”Eight of the top 10 textile companies that had declared their Q1 results have seen lower revenue growth, compared to the full-year numbers for 2007-08; five of these companies have shown negative growth. The profitability picture is no better (See table). Unlike software companies, Indian textile companies can’t absorb a margin loss. If the rupee keeps rising and realisations keep falling, they will be left with no choice but to hike product prices. The danger here is that the Wal-Marts and JC Penny’s might simply go to another country.Among the three sectors, textiles has the most to lose and the most to change. Says Hinduja: “We can improve productivity, charge higher product prices and move to value-added products, which offer greater pricing power.” The final word belongs to Chirag Khasgiwala, textiles analyst, Emkay Share & Stock Brokers: “A 10-20 per cent drop in profits is likely. I don’t see strong buying potential currently.”

Auto ancillariesAuto ancillaries fall in between IT and textiles. Average exports as a percentage of revenues have risen from 5-8 per cent to about 15 per cent in the past two to three years.Nine of the top 10 auto ancillary companies who have declared their Q1 numbers have reported a drop in net profit growth, compared to 2006-07. India faces competition from neighbouring countries like China, Vietnam, Mongolia and Bangladesh, but there are barriers to a shift. Says Gokarn: “Companies like GM invest a lot to set up a supply chain, which can’t be abandoned like that.”Since the industry imports some of its raw materials, it gets a natural hedge against the rupee. Also, the percentage of exports is still not as significant as textiles or software to press the panic button. Two stocks that are good buys even now are Bharat Forge and Minda Industries.