Soaring IT Profits is Just a Mirage for Investors

HCL Tech reported revenue growth of 9% in the third quarter, which is 1.4% less than the previous quarter, but the constant currency revenue growth in Q3 2023 is 2.7% less than the revenue growth reported in Q2 2023.
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Quarterly results of the majority of the IT companies are out and they have raked in huge amounts of moolah. At least, that’s what it appears from outside. But, considering the falling rupee value in proportion to dollars, the full picture looks a bit skewed when observed closely.

Most Indian IT companies have a huge market in the USA and UK, with more than 60% of their revenue originating from these companies. In addition, since they are earning in dollars and euros while spending in rupees, the operating margins of these companies increase when the rupee declines, thereby resulting in higher revenue when calculated in rupees. 

For instance, Rupee (INR) lost roughly 3% of its value during the third quarter of FY23. For IT companies, a 100-basis-point decline in the value of the Rupee against the Dollar often results in a 30-basis-point increase in operating profit. This inevitably leads many IT companies in India to benefit from the rupee depreciation. 

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The TCS Q3 results were reported with much fanfare, as the company’s profits soared by 19.1%. This represents an increase of 1.1% from the previous quarter (18%). While the media outlets highlighted this impressive growth, they failed to mention an important detail. The profit figures were reported in Indian Rupees (INR), whereas TCS earns its revenue in US dollars. This is significant because the rupee has recently depreciated by roughly 3%. As a result, TCS’ profit margins actually improved, fuelling a positive growth in revenue.

However, when it comes to constant currency, TCS’ revenue growth is down by 1.9% as compared to Q2 2023. In Q2 2023, TCS reported revenue growth of 15.4%, while in Q3 2023, it trickled down to 13.5%. 

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AIM Insight: Constant currency is the exchange rate used to eliminate fluctuations when calculating the financial performance numbers for publication in the financial statements of a particular company. 

Much like TCS, HCL Tech reported revenue growth of 9% in the third quarter, which is 1.4% less than the previous quarter, i.e, 10.4%. But when we look at the constant currency value, the revenue growth in Q3 2023 stands at 13.1%, which is 2.7% less than the revenue growth reported in Q2 2023, i.e, 15.8%. 

“The constant currency calculation is very complicated as the countries in which a particular company operates might vary,” said Pareekh Jain, CEO EIIRTrend. “In some countries, the value of the rupee might be higher than the local currency, while in others, it might be depreciated.”

For example, if a company earns revenue of INR 65,000 crores in the second quarter of a financial year and INR 9,000 crores in the third quarter, it shows a profit rise of 38.46%. However, if the exchange rate of INR was 65 in the second quarter and 75 in the third quarter, the revenue earned in the third quarter has a significant amount owing to the depreciation of INR. 

If we consider the same case in terms of USD, we note that revenue earned in the second quarter was USD 100 and USD 120 for the third quarter. In this case, the revenue has increased by 20%. The difference of 18.6% in revenue is caused by currency depreciation, which is where constant currency comes into play. 

Jyoti Prakash Gadia, MD, Resurgent India, told Analytics India Magazine that since a major part of the earnings for IT companies are in dollars, the net margin is impacted not only by operational efficiency and cost reductions but also due to the benefit arising from rupee depreciation.

“The exact amount of impact will vary over the period depending on the extent of rupee depreciation and accounting policy adopted by the company for foreign currency valuation and profit booking at the end of each quarter/financial year,” said Gadia. 

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