IT Sector Analysis Based On Recent Financial Results

Investors are once again flocking to IT counters after shunning the sector for an entire year. The rebound in investor sentiment is evident from the fact that though IT indices have failed to provide returns over a 12-month horizon, they have by and large outperformed the broader market over one-month and three-month periods.

The renewed interest of investors despite not-so-encouraging results can be attributed to the weakening of the rupee against the dollar. Post the March quarter results and favourable trend in currency fluctuations, the time is right to take a look at the prospects of the IT sector. So far, over 100 large and small software and BPO companies have declared results for the March ''09 quarter and the picture at the aggregate level is not too encouraging.

The performance of the IT sector is even bleaker on the profit and profitability fronts. Growth in net profit for the sector during the March ''09 quarter was the slowest in the past several quarters. This is also true in case of profitability of the IT sector. The sombre performance has come on the back of an appreciating rupee and slower growth in the BFSI segment. For FY10, though IT companies have maintained their ''cautiously optimistic'' stand, the guidance given by large and mid-sized companies reflects their confidence in maintaining growth.During the June ''09quarter, depreciation in the rupee against the dollar may help companies post better margins.As per industry experts, every 1% fall in the rupee will improve companies'' operating profitability by over 30-35 bps.

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Most IT companies have hedged their future earnings in the currency forwards market.Companies typically hedge 30-75% of their future earnings. This reduces the impact of currency fluctuations on their revenues and profitability when the rupee is appreciating. But this will result in erosion of profitability when the rupee stars depreciating.Though a depreciating rupee will increase hedging losses, this may be more-than-compensated by gains on the operational front as companies have flexibility to rework their hedging strategies, depending upon the rupee''s fluctuation.

Over the long term, the IT sector is set to see moderate growth, given fattening revenue base of the sector and slowing US economy. This may be reflected in companies' current valuations. IT exporters with a strong business model and ability to take advantage of global sourcing opportunities by relocating their delivery base can tide through the bad patch. Also, companies that have India-centric strategies woven through niche market offerings look promising.Investors with a horizon of 2-3 years can accumulate scrips of top-tier companies, like TCS and Infosys, as well as niche players in the mid-tier space, such as Rolta, Mastek and Tulip Telecom.