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Rupee rise to bring to fore hedging strategies of Indian companies

LiveMint logoLiveMint 08-08-2017 Shakti Patra

Mumbai: With the Indian rupee rising to its best levels against the US dollar in the last two years, the jury is out again on the impact of a strong rupee on the Nifty’s earnings, particularly given the heavy weight of export-oriented information technology (IT) and pharmaceuticals companies in it.

The rupee closed at 63.81 against the US dollar on Monday. So far, this calendar year, it has gained 6.4% against the greenback.

A very strong rupee will be terrible for the Nifty’s earnings, said Raamdeo Agrawal, managing director and co-founder of Motilal Oswal Financial Services Ltd.

“Businesses pencil in a certain level of the rupee while taking decisions. So, if it strengthens a lot, say to 55 or so, it will have a very negative impact,” Agrawal said.

He, however, thinks that maintaining the rupee at a certain level is now entirely in the Reserve Bank of India’s (RBI’s) hands, given the massive forex reserves it is sitting on. 

Agrawal’s fears can be validated by the fact that several large IT and pharma companies’ earnings are highly inversely related to the rupee’s strength.

IT major Infosys Ltd, for instance, estimated in 2016-17 that every 1% appreciation in the rupee would push its operating margin lower by 50 basis points.

No wonder, as of 2016-17, it had increased its hedges against the rupee’s appreciation by 45.1% to Rs8,753 crore or well over 10% of its annual revenue of Rs68,484 crore. A basis point is a hundredth of a percentage point.

Curiously, pharma major Lupin Ltd, despite estimating that its bottom line would have dropped by Rs25.1 crore for every additional 1% strength in the rupee in financial year 2016-17, has been continuously reducing its exposure to short dollar forward contracts from $333 million in financial year 2014-15 to $96 million in financial year 2016-17.

What makes this more interesting is the fact that during these three years, its balance sheet’s net exposure to the US dollar has risen from Rs2,036.6 crore in 2014-15 to Rs2,505 crore in 2016-17. 

A forward is a contract between two parties to buy and sell an underlying asset at a specified price on a future date and is a popular hedging instrument. 

U.R. Bhat, managing director of Dalton Capital Advisors, believes it’s such divergent hedging strategies that make it very difficult to ascertain the impact of the rupee’s strength on a companies’ earnings. “If a company has the pricing power and can pass the impact of forex volatility to its customers, it won’t really be affected by an adverse move in the rupee,” Bhat said. 

What makes such impact analysis all the more difficult is the fact that there are also companies like Cipla Ltd, which, despite earning a majority of its revenue from overseas, would actually be enjoying the current leg-up in the rupee.

That’s because while its net dollar receivables at the end of financial year 2016-17 was Rs184.9 crore, it was short Rs428 crore worth of dollar-rupee forward contracts. It’s these forward contracts that would now be more than compensating for its loss of realizations in receivables.

In fact, a detailed analysis by Mint reveals that Cipla is a rare net exporter that has consistently followed a strategy of positioning itself in such a way that it benefits from a strong rupee and not a strong dollar. 

“Fortunately, Cipla’s P&L (profit and loss) statement is not that highly dollarized. Hence, we will not be affected that badly. But other large peers may get impacted in terms of margins and might also have cash-flow issues although they must be having strategies in place to minimize the impact,” Kedar Upadhye, global chief financial officer of Cipla, told Mint. 

There’re also non-pharma non-IT companies which have been systematically reducing their foreign currency hedges over the years—such as Bajaj Auto Ltd.

Nitesh Sharma, an analyst with Philip Capital, is of the opinion that the appreciating rupee will adversely impact Bajaj Auto’s margins next year even if the exchange rate remains at current levels. “For this fiscal, Bajaj Auto is hedged at Rs66.5 to a dollar.

Therefore, the appreciating rupee will not have any impact on the company this year. The rupee is currently at Rs63.6 and its realization for Bajaj, next year, will be around Rs64, thereby impacting its earnings before Ebitda (earnings before interest, tax, depreciation and amortization) by 5-6%,” Sharma said. S. Ravi Kumar, president of business development and assurance at Bajaj Auto declined to comment, citing competitive reasons. 

An additional factor in the rupee’s impact on the earnings of export-oriented companies in financial year 2017-18 will be the fact that the recognition of hedging gains/losses and their impact on a company’s earnings per share (EPS) has undergone a big change with the adoption of Ind-AS (Indian Accounting Standard).

“Now, all outstanding financial derivative instruments that a company has exposure to need to be fair valued (marked-to-market) and recorded through financial statements. Earlier, under Indian GAAP (generally accepted accounting principles), companies were required to account only for the losses and there was also a lot of diversity in practice,” Sandip Khetan, partner in an Indian member firm of EY Global, said.

At the same time, even within Ind-AS, forex gain/loss-related earnings volatility is likely to be higher between those that have opted to use hedge accounting and those that haven’t, Khetan added.

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