BSE 500 Corporates: Increased margin sensitivity to currency movement - India Ratings

Mumbai, May 15, 2014: India Ratings & Research (Ind-Ra) says that the margin sensitivity of BSE 500 corporates (excluding banking and financial services) to foreign exchange fluctuations has shown a rising trend since FY07-FY13. This may be attributed to the rising level of dollarisation of the income statements and balance sheets of Indian corporates since 2007. The foreign currency (FC) revenue as a proportion of total revenue was 20.1% in FY13 (FY07: 17.1%) and FC expenditure as a proportion of total expenditure was 41.8% (38.6%).  As may be expected, in a net importer nation such as India, its largest corporates on aggregate had more FC outflows than inflows. The corporate level foreign currency deficit since 2007 grew at a CAGR of 17.8% to INR6,353bn in FY13 (FY07: INR2,383bn).

Over half of these corporates have operating structures which make them net FC spenders. These corporates, account for around 70% of the balance sheet debt (as of FY13) of BSE 500 corporates. On an average, these FC spenders are expected to suffer operating margin deterioration of 1.3% in EBITDA (in INR terms) for every 1% depreciation in the Indian rupee against the US dollar. The challenge for these net FC spenders is aggravated since 17% of their aggregate debt is foreign currency debt. The possible imbalance between currency of debt funding and operating cost structure may be reflected in the fact that 76% of the total FC debt (often unhedged) of BSE 500 corporates (as of FY13) lies with net FC spenders.

However, slightly less than half of the BSE 500 corporates are net FC earners and they are estimated to enjoy a 1.6% increase in EBITDA margins (in INR terms) for every 1% INR depreciation.

The study rank orders the sectors in terms of their positive and negative sensitivity to currency volatility. Positive sensitivity in this study refers to improvement in operating margin (in INR terms) due to rupee depreciation, while negative sensitivity refers to deterioration in operating margin due to rupee depreciation. However, during rupee appreciation the direction of the impact reverses in these two categories.

The two sectors with the highest positive sensitivity to rupee depreciation are information technology (IT) and pharmaceuticals. For every 1% rupee depreciation on a sustained basis, the median expansion of EBITDA (in INR terms) for IT companies has been in the range of 2.7% to 2.9% while for the pharmaceutical sector it has been 1.2%-1.5% over FY12-FY13.

Corporates with higher sensitivity tend to exhibit higher volatility in EBITDA margins. For instance the IT companies which historically have the highest positive sensitivity such as Tata Elxsi Ltd, Polaris Financial Technologies Ltd and Mindtree Ltd (‘IND AA’/Stable) are likely to be the highest beneficiaries of INR depreciation. However industry leaders such as Infosys Ltd, Tata Consultancy Services Ltd and Wipro Ltd, which have relatively lower positive sensitivity would be much better placed to handle two way currency movements and exhibit relatively less margin volatility. The lower sensitivity of these industry bellwethers can be attributed to their relatively large scale of on-shore operations, which causes them to incur significant FC expenses as well.

Consumer durables has exhibited the highest negative sensitivity in the range of 1.2% to 2% in case of a 1% INR depreciation, due to major FC outflows on imports of electrical components. Other corporates in sectors such as fertilisers, chemicals, and automotive suppliers have displayed a negative sensitivity change to rupee depreciation, with their EBITDA getting affected to the extent of 0.5% to 1.4% in FY13 for 1% of INR depreciation. However, the margins of these sectors would benefit the most in case the rupee appreciates.

Further, Ind-Ra has identified and listed the top 15 companies most sensitive to rupee depreciation and rupee appreciation within the BSE 500 universe. The last 18 months have seen significant two-way volatility of the INR/USD rate and the situation may continue in the future. This study quantifies the sensitivity of margins of BSE 500 corporates to change in the INR/USD rate and endeavours to provide insight to lenders and other investors on the direction and size of the impact of the change in the INR rate.

(Source: Manager - Corporate Communications and Investor Relations, India Ratings & Research-A Fitch Group Company.)