RESULT UPDATE Infosys Technologies — ‘Beat’ and ‘Raise’ continues says Ambit

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RESULT UPDATE
Infosys Technologies — ‘Beat’ and ‘Raise’ continues

We believe that Infosys’ FY11E US$ revenue guidance upgrade of 4-5% (to +24-25% YoY) and increase in gross hiring target by 11% reinforces our view of a strong demand environment. EPS guidance upgrade of 0.2-2.5% (to Rs115.1-117.1) was lower due to rupee appreciation (US$/INR assumption at Rs44.5). We continue to believe that strong offshoring momentum, pick-up in discretionary spending and strong growth in top-10 clients will drive robust growth in FY11-13E. While rupee appreciation worries have come back to haunt the sector, we believe that a reasonable rupee appreciation can be managed. We continue to maintain BUY with a September 2011 target price of Rs3,670 (22x TTM 2Q FY13E EPS).

• FY11E guidance upgrade reinforces our confidence on the demand trajectory: Infosys has again positively surprised on the FY11E US$ revenue guidance upgrade to US$5.95-6.0bn, implying growth of 24-25% YoY (v/s Ambit est. of 22-24%). We believe that guidance upgrade infuses further confidence on the demand trajectory. 3QFY11E revenue guidance at US$1,547-1,562 mn, implies a growth of 3.4-4.4% QoQ. 3Q is a seasonally weak quarter given the lower number of billing days. The guidance however, implies a flat-1.3% QoQ growth in 4QFY11E, which in the light of the strong revenue beat in this quarter appears overly conservative. The company has also revised its gross hiring target for FY11E upward by 11% to 40,000 (v/s 36,000 earlier).
• EPS guidance upgrade by 0.2-2.5%, primarily lower due to rupee appreciation: Despite a strong FY11E US$ revenue guidance upgrade, EPS guidance (at Rs115.1-117.1) has been upgraded only by 0.2-2.5% (v/s earlier Rs112.2-116.7) due to rupee appreciation (US$/Rs at Rs44.5 v/s earlier at Rs46.45). Guidance factors in a margin decline of 130bps (v/s earlier 150bps).
• 2QFY11 revenue higher than expectation, driven by volumes and increase in pricing realization: 2QFY11 US$ revenue at 1,496mn increased by 10.2% QoQ (v/s estimate of 8.3%) and was higher than the upper end of guidance by 5.1%. Volumes grew strongly at 7.2% QoQ in IT services, while the pricing realization increase of 3.2% QoQ was a positive surprise. Constant currency pricing realization improved by 2.5% QoQ, which management attributed to a change in the services mix. The company also reported strong deal wins during the quarter-9 transformational deals in 1HFY11, out of which 6 have been won in 2QFY11 (many >US$100mn and couple of them >US$200mn TCV).
• EBITDA margin increase of 167bps lower than estimate: EBITDA margin at 33.3% implies a increase of 167bps QoQ (v/s est. +220bps). Margin increase was primarily led by increase in pricing realization (+3.2% QoQ), utilization (74.3% in 2QFY11 v/s 73% in 1QFY11; including trainees) and exchange rate movements (+80bps). PAT at Rs17.37bn increased by 16.7% QoQ (v/s est. 16.1% QoQ despite increase in tax rates (26.6% v/s 25.4% in 1QFY11).
• Retail, Energy & Utilities and Europe were the trailblazers: Retail (+19.9%) and Energy & Utilities (+15.4%) verticals grew at a scorching pace while Insurance also grew well at 11.2% QoQ. Management mentioned that while they are witnsessing a decline in the core M&A work, there is incremental demand in risk management and regulatory compliance areas.

• Geography-wise, Europe witnessed a strong comeback (18.1% QoQ in US$ terms, 15.6% in cc). Management mentioned that they are seeing increased traction in Telecom and BFSI verticals in Europe. Amongst service lines, consulting and PI (+13.9%), system Integration (+49.2%), engineering services (+30.9%) and testing (+14.4%) were the primary growth drivers. Further there was strong growth in the top 2-5 client (+16.2% QoQ) and top 6-10 clients (+12.0%).
• Attrition rate continues to head upwards: Attrition at 17.1% continues to shoot up (15.8% in 1QFY11). However, management mentioned that they are witnessing a reduction in attrition rates on a MoM basis since August and the absolute numbers are lower in 2QFY11 at ~4,200 (v/s ~5,400 in 1QFY11). The promotion cycle (benefiting 12,000 employees) which has been planned for 3QFY11E could also help arrest the attrition rates. Management noted that the promotions were considered in the earlier FY11E EPS guidance as well.
• Maintain BUY with Sep-11 TP of Rs3,670: We are marginally increasing our EPS estimates to Rs122.5 (+3%) and Rs151.3 (+2.0%) for FY11E and FY12E respectively. We are also introducing our FY13E estimates  expect EPS at Rs184.1 (+21.7% YoY). The stock currently trades at 25.2x and 20.4x  on FY11E and FY12E EPS. We continue to believe that higher offshoring momentum, pick-up in discretionary spending and strong growth in top-10 clients will drive strong growth in FY11-13E. While rupee appreciation worries have come back to haunt the sector, we believe that a reasonable rupee appreciation can be managed. We continue to maintain our BUY recommendation with a target price of Rs3,670 (22x TTM 2Q FY13E EPS).