Re rise may dent IT cos' bottomline in Q2

- Operating margins of top-5 IT firms already fell by 80-130bps in Q1

- Indian IT firms are already facing cost pressure due to high wage cost

- Lining up of 10 more IPOs in September will support rupee

- Expanding margins are a key factor for valuations

- Pressure on margins will also influence valuations of IT firms

Bengaluru: Indian IT companies may see further margin pressure in the second quarter as rupee strengthens against the US dollar. Domestic IT companies are already facing cost pressure arising from rising wage cost on the back of strong demand environment. Even gradual return of normalcy is leading to higher SG&A (selling, general & administrative) expenses as employees come back to offices in some regions across US and Europe apart from resumption of travel.

In such an environment, strengthening of rupee can add further pressure on the margins in the current quarter. Rupee is currently trading at two-and-a-half-month high of 73 per dollar in recent days. The currency has gained 1.4 per cent in just the last five trading sessions. Usually, one per cent appreciation in rupee leads to 25-30 basis points (bps) impact on the margin. According to experts, rupee will continue to garner support from the equity markets as more than 10 companies will come up with their IPO offerings in September.

Against this backdrop, the dream run of Indian IT companies in the stock exchanges is facing the risk of being disrupted as expanding margin is considered as the key parameter for valuation.

"A strengthening rupee definitely adds to the cost pressure of Indian IT firms which are seeing significant rise in expenses towards wage costs. Also, many of the pre-Covid expenses are also coming back. Therefore, it doesn't augur well at this juncture," said a Mumbai-based analyst with a large brokerage firm. He, however, said that rupee at 73 level has not significantly moved from the last quarter level. "Any further appreciation from these levels will have to be factored in valuation," he added.

Operating margin of all top-5 IT firms has fallen during the first quarter of this fiscal year ended June. Market leader Tata Consultancy Services' (TCS) operating margin fell 130 basis sequentially to 25.5 per cent in Q1 of FY22. Infosys' operating margin was at 23.7 per cent, a drop of 80 basis points from the last quarter. While Wipro's margin dropped 220 basis points at 18.8 per cent, HCL Technologies margin saw 160 basis points drop at 24.5 per cent. For Tech Mahindra, operating margin fell by 160 basis points to 18.4 per cent in Q1 of FY22.

Not only operating margin dropped for the tier-I companies, mid-tier IT firms also saw similar scenario in April-June period.

For the second quarter, though demand environment remains strong with many companies announcing large deals, cost pressure owing to wage hikes, higher attrition and bonus payout remains the key risk to operating margin.

"There are many levers available for the IT firms to compensate for the rising wage cost and strengthening rupee. Strong demand, employee pyramid rationalization by hiring freshers, and rising offshoring are some of the levers that will offset the cost pressure," said another analyst. He, however, said that any significant move in rupee against dollar would reflect on the margin profile.