IT stocks rally as rupee continues to tumble

The rupee has continued its steep slide down-hill, to tumble down below the Rs 52 mark and touch new lows of Rs 52.72 per dollar. However, in a surprising relief, the markets turned positive today and managed to bring some cheer to the investor community. In fact, the market bias seemed to be positive for the day, without much volatility.

Accompanied by the positive market sentiment, the BSE IT Index today comfortably notched up a 2% gain as the rupee weakened further. IT bellwether Infosys has been the top gainer, up 2.5% at Rs 2727.10. This is despite CFO V Balakrishnan's word of caution that the company may miss the upper end of its sales targets for Q3 December 2011 and the financial year ending March 2012, as the worsening global economic situation has made large contracts hard to come by.

Amongst other gainers, TCS and Tech Mahindra have managed to notch up over 2% each. Proposed de-listing candidate, Patni Computer  Systems has been the only notable loser, down by 0.29% at Rs 429.50.

It is pretty evident that the chief reason for the positive movement in the IT stocks is a result of depreciating rupee, which gives rise to expectations of increased revenue. A weak rupee boosts IT firms' revenue in rupee terms, as the sector derives a lion's share of its revenues from exports.

The IT Index also witnessed a heavy sell-off in the past 8 trading sessions, losing more than 5%. One can expect this to be a result of short covering activity. Moreover, at a time when the import-oriented sectors are feeling the heat of forex losses and a rise in interest burden, it is always a safe bet to stick to the export-oriented IT sector.

Another factor for pushing the prices of IT companies up north are some positive comments made by NASSCOM, which is confident that the sector would achieve a 16%-18% growth for this fiscal.   

However, the question that remains to be answered is can the IT stocks sustain this rally. We, at DSIJ, believe that in view of the broader market sentiments, IT companies will face some pressure on the earnings front in the coming quarters, as a slowdown in demand following the debt crisis in the Euro zone and the economic slowdown in US will tighten their customers' purses.

Ideally, a weak rupee coupled with a strong US dollar boosts exports revenue and margins. But if there are concerns about the revenues itself, a favourable currency is not of much help. This seems to be the case with IT companies.

The rupee's depreciation will certainly boost margins in the seasonally-weak Q3, depending on the quantum of hedging done by the IT companies. Going forward though, the global economic slowdown will weigh down IT companies' earnings. If anything, the weakness in the rupee will merely serve to cushion the pressure on revenues.

To sum up, we advise investors to stick to the likes of Infosys, TCS, HCL, Wipro, Tech Mahindra etc., rather than fishing in the Mid-Cap space for cheaper bets and ending up getting swallowed by the sharks there. One must also look closely into the order flow of IT companies, as companies that receive orders for cloud computing, leverage applications, social media and mobile software may not witness much sluggishness. Customers are not likely to cut back much on these expenses.