Evaluating the impact of rupee depreciation

The 22% drop in the rupee against the dollar is worrying to say the least. There are several ramifications for the Indian economy, if the slide continues.  Anything which impacts the economy, is bound to impact the stock market as a whole.

One can find a dizzying array of macro-economic analysis on the impact of the rupee depreciation and as many forecasts of the future levels of the exchange rate.

I personally consider macro-economic analysis too complex due to the huge number of variables involved in it and hence any analysis from my end is as good as yours. Instead I have been trying to evaluate how the rupee depreciation will impact my portfolio on an individual stocks basis.

I think there are three factors through which the fundamental performance  can get impacted

Factor 1: Level of Raw material / capital good import

What is the level of raw material / capital goods imported by the company?. If the company imports a substantial amount of raw material/ capital goods then it is likely to get impacted severely, if it cannot pass on the costs to the end user without impacting the volumes

Factor 2: Level of export

What is the level of export sales in the revenue of the company. A high level of export will benefit the company, if the company can maintain or improve its margins as a result of the rupee depreciation.

Factor 3: Level of foreign debt

What percentage of debt is ECB (external commercial borrowings) or FCCB? There are two key points to note here – What is the maturity schedule (payment timing) and the level of debt in comparison to equity / market cap?

The above three factors cannot be looked in isolation and have to be combined to come up with a final impact on your company.

For example – A company may have a high level of export and imports, with the exports exceeding the imports (due to value addition on the raw material). In such a case, the company will have a net benefit.

 A company using domestic inputs and exporting most of its output will gain the most from the depreciation (IT and pharma). Conversely a company using imported inputs and selling most of it domestically will be hurt badly (Oil companies).  Finally a company with high level of imported inputs, selling domestically and also carrying a high level of foreign currency debt is toast (to put it politely)

If level of export >= import + debt payment (ok)

If export < import + debt payment (trouble)

Let me give you two examples of the analysis I am currently doing on my portfolio stocks

Balmer lawrie

The company has zero debt and actually has excess cash of around 200 Crs. So we do not have forex related debt risk with the company

The company imported around 4% of its inputs and earned roughly the same amount in exports.  So at first glance, the company has close to zero risk from higher raw material costs due to currency depreciation. However the grease and lubes division uses various base oils which are petroleum based and will be impacted by the price of crude oil. As the division does not have much of a pricing power, the net margins of this division are likely to be impacted.

The other divisions such as logisitics and tours & travel are unlikely to be impacted directly due to the currency depreciation.  However the overall business will definitely be impacted by the overall slowdown in the economy.

Lakshmi machine works

The company has close to 700 Crs+ excess cash on the books and hence the risk of forex debt does not exist.

The company exported around 250 Crs of machinery and components in 2011 and imported roughly the same amount in terms of raw materials and spare parts. As a result , the company is unlikely to get directly impacted by the rupee depreciation. On the contrary, the company could benefit to a certain extent as the competitive pressure from imported machinery will reduce.

Finally I think that the textile industry level issues will have a bigger impact on the company performance than the currency depreciation.

Not a quantitative analysis

The above analysis is not a precise numerical analysis and I would be suspect of any such analysis, as there are too many variables which impact the performance of a company. The best one can do in the current circumstances is to figure out if your portfolio company falls in the high risk or low risk bucket (due to the currency depreciation).

If the risks are too high (even if not quantifiable), then one should consider reducing the position size even if it results in a loss

Stocks discussed in this post are for educational purpose only and not recommendations to buy or sell. Please read disclaimer towards the end of blog