Two Reasons to Buy Indian IT Companies

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The Indian rupee dropped to record lows recently, and is expected to remain under pressure. While a depreciating currency does not augur well for the Indian economy, it should benefit Indian IT companies such as Syntel (NASDAQ: SYNT), Infosys (NYSE: INFY), and Wipro (NYSE: WIT). These companies are also expected to benefit from an ongoing improvement in the U.S. economy, making them an attractive proposition right now.

Falling rupee

Emerging market currencies have come under pressure in the last few months as speculation that the Federal Reserve will start scaling back its $85 billion a month bond purchase program soon has strengthened the U.S. dollar. The Indian rupee has been one of the worst performing emerging market currencies. The rupee’s fall has been exacerbated by India’s mounting current account deficit.

The rupee dropped to an all-time low of 61.79 against the dollar last week. More importantly, the Indian currency could remain under pressure as the Federal Reserve is likely to start easing its bond purchase program as early as next month. Charles Evans, the Chicago Fed President, said on Tuesday that growth in the U.S. economy in the second half of the year is expected to accelerate to 2.50%, and based on this projection, the Fed is likely to scale back its bond purchase program starting later this year.

Evans’ comments suggest that the dollar will strengthen further against emerging market currencies.

Rupee’s slide to benefit Indian IT companies

The sharp decline in the rupee is a major concern for Indian policymakers, but for Indian IT companies, this could boost top-line growth as they generate a significant portion of their revenue from the U.S.

Syntel generated around 93% of its revenue from North America in the second quarter. In fact, two U.S. companies, American Express and State Street Bank, accounted for almost 42% of the company’s total revenue in the quarter. Syntel said in a filing that the rupee depreciation against the dollar positively impacted the company’s gross margin by 1.44% in the second quarter.

Syntel has forecast 2013 revenue of $800 million to $815 million and earnings of $4.65 per share to $4.75 per share. The company’s forecast is based on an exchange rate assumption of 59 Indian rupees to the dollar. However, with the rupee breaching the 61 mark, there is likely to be an upward revision to the 2013 revenue forecast.

Wipro, which generated nearly half of its June quarter revenue from Americas region, forecasts that revenue from its IT services business will be in the range of $1.62 billion to $1.65 billion in the quarter ending September 30. The forecast is based on dollar/rupee exchange rate of 57.24. This is conservative, given the slide in the rupee.

Improving U.S. economic environment

Indian IT companies registered healthy revenue growth in their recently reported quarterly results. For the quarter ended June 30, Infosys reported revenue of $1.99 billion, up 13.6% from the same period in the previous year. Wipro’s revenue from continuing operations for the June quarter stood at $1.64 billion, up 5% on a year-over-year basis. Syntel reported a 13% increase in second quarter revenue.

Moreover, Indian IT companies can expect revenue growth rates to improve in the coming quarters, given the improved U.S. economic environment. As the Chicago Fed President noted in his speech on Tuesday, growth in the U.S. is expected to accelerate in the second half of the year. Certainly, there are strong signs it will, as evidenced by recent economic data. Last week, the Institute for Supply Management, or ISM, reported that the pace of growth in the U.S. manufacturing sector accelerated in the month of July. A separate report from the ISM showed that the U.S.’s vast services sector also expanded more than forecast in July.

Azim Premji, Chairman of Wipro, is also encouraged by the improving U.S. economic outlook. Last month, Premji said that the company is seeing higher confidence among its clients on the backdrop of positive macroeconomic developments, particularly in the U.S.

Indian IT companies look attractive 

Given the macroeconomic developments, and a gloomy outlook for the Indian rupee, Indian IT companies certainly look attractive right now. In terms of valuation, Syntel is probably the best bet. The company currently trades at a P/E ratio of 15.39, compared to a P/E ratio of 16.24 for Infosys and 23.67 for Wipro. Syntel’s revenue growth of 13% is also in-line with the industry average. Although Syntel is currently trading near its 52-week high of $73.06, I think there is further upside potential.

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Varun Chandan Arora has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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