13 January 2011

Citi: Infosys Technologies : Q3 Results Below Expectations

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Infosys Technologies (INFY.BO) 
 Q3 Results Below Expectations 
 
 Volume growth of ~3% QoQ — Infosys 3QFY11 results were below CIRA/Street
expectations with revenue growth of ~6% QoQ (US$1,585m). Constant currency
growth at 4.7% QoQ was disappointing. Volume growth of ~3% QoQ was the
lowest since the recovery picked up. Pricing (in constant currency) was up ~50bps
QoQ. 4Q guidance of 1%-2% revenue growth is sluggish as well. FY11 revenue
guidance was raised to ~26% growth YoY (slightly below expectations).

 EBITDA margins in line; Profits below expectations — EBITDA margins at
~33.3% were flattish QoQ – cost management remains strong. Net profit at
Rs17.8b was lower than our expectation of Rs18.5b due to the weaker topline,
lower than expected other income, and higher tax rate.
 Management commentary positive — Infosys management indicated that: (a) IT
budgets are expected to be flat to marginally up and CY11 is likely to be a normal
year for the industry; (b) Expect volatility due to uncertainty in the environment; (c)
Slightly negative on Europe; Positive on North America; (d) Pricing uptick will take
time – sporadic cases of price uptick; (e) Making ~26k campus offers for next year.
 Will the results drive EPS downgrades? — The weaker-than-expected revenue
and 4Q topline guidance will result in lower exit rate on revenues going into FY12.
While the Street will likely wait for a couple of quarters before revising FY12
estimates, and a weaker INR may also help, the risk on FY12 revenue estimates
has gone up slightly, in our view.
 Sector view unchanged; Prefer HCLT — While the business outlook remains
robust, high expectations/valuations continue to drive our “neutral” view on the
sector. TCS earnings are the next key data point – any disappointment could be a
big concern. On a relative basis, we continue to prefer stocks with reasonable
valuations - HCLT/Wipro. HCLT is our top pick – we expect continuation of good
growth with visibility of margin improvement in the coming quarters.


Key Highlights
 Revenues were US$1,585m, up ~6% QoQ (CIRA expectations:
US$1,596m).
 EBITDA margin of 33.3% (CIRA expectations: 33.3%), flattish sequentially.
This was primarily on account of pricing improvements and favorable crosscurrency despite lower utilization and INR appreciation.
 Net profit of Rs17.8b vs. our expectations of Rs18.5b – lower due to lower
topline, lower-than-expected other income, and higher tax rate.
 Constant currency realizations improved on a blended basis – offshore
realizations improved ~140bps while onsite was flattish QoQ.
 IT volumes increased 3.1% sequentially on a blended basis – offshore
volumes increased 3.5% QoQ while onsite showed a growth of 2.3% QoQ.
 Headcount increased by 5,311 employees on a net basis. Management has
retained full year hiring guidance – expecting to add ~40,000 employees
(gross) in FY11.
 Management expects to make ~26,000 campus offers for FY12 – the
acceptance ratio has been ~70-72%.
 Growth was led by Manufacturing and Banking & Financial Services where
revenues increased by 9.9% and 9.5% QoQ respectively. Telecom was
flattish while Energy and Utilities was relatively slow at 2.6%.
 Management indicated that there was no budget flush in 3QFY11.
 In terms of Service lines, growth was led by Consulting & Package
Implementation, Application Development, and Testing at 6.4%, 5.9% and
5.9% QoQ respectively while Application Maintenance and Infrastructure
management were sluggish at 1.4% and 2.5% QoQ respectively.
 BPO subsidiary had revenue growth of ~5% QoQ; net margins expanded
further to ~15% (~8% in 1Q).
 Top-10 clients grew ~2% QoQ while clients outside this bucket grew ~7%.
 Attrition increased by ~40bps on a LTM basis, however, management
indicated that absolute number of employees leaving the company declined
in 3Q (~4,200) vs. 2Q (~3,400).
 FY11 guidance now implies ~26% revenue growth ($-terms) and ~Rs119 on
EPS.


Infosys Technologies
(INFY.BO; Rs3,251.00; 2L)
Valuation
Our Rs3,220 target price for Infosys is based on 22x Mar-12E EPS. This is
close to the higher end of the last 3-year trading band of 10-24x 12-month
forward earnings and factors in marginal deceleration in growth. Our estimates
continue to assume a certain PE premium to the market; this is justified, in our
view, given the strong FCF and ROIC for Infosys vs. the overall market. We
believe PE remains the most appropriate valuation measure given Infosys'
profitability record and higher earnings visibility.
Risks
We rate Infosys Low Risk which is inline with our quantitative risk-rating
system, which tracks 260-day historical share price volatility. Key downside
risks to our target price include: (1) any significant appreciation of the rupee
against the USD/EUR/GBP; (2) pressure on billing rates (as the company
continues to enjoy a premium in its billing rates); and (3) a prolonged slowdown
in the US economy. Key upside risks that could cause shares to exceed our
target price include: (1) a sharp recovery in the US/Global economy; and (2)
any significant depreciation of the rupee against the USD/EUR/GBP.
HCL Technologies
(HCLT.BO; Rs470.75; 1L)
Valuation
Our target price is Rs510 based on 18x Mar-12E EPS. This is higher than the
mid-point of the 5-20x band that the stock has traded in over the past three
years. We believe a higher multiple is justified given improving macro and
potential benefits arising out of the Axon acquisition. We believe PE remains
the most appropriate valuation measure given HCLT's profitable track record.
Risks
We rate HCLT shares Low Risk which is inline with our quantitative risk-rating
system as the company has significant scale, enjoys a good brand name and
continues to generate significant FCF. Key downside risks that could impede
the stock from reaching our target price include: (1) any significant appreciation
of the rupee against the USD/EUR/GBP; (2) a sharp slowdown in the
US/Global economy; (3) acquisition-related risks; and (4) the strategy of
pursuing large deals could have negative margin implications.


Wipro
(WIPR.BO; Rs472.00; 1L)
Valuation
Our target price of Rs490 is based on 20x Mar-12E EPS. Our target multiple is
derived from a PE-band analysis of Wipro's historical trading pattern and peer
group valuations. Wipro has traded at 6-22x over the past three years. Given
that revenue visibility is improving with business environment stabilizing, we
believe Wipro should trade higher than the mid-point of the band. We think
Wipro will continue to trade at a discount to Infosys. PE is the most appropriate
valuation measure, in our view, given Wipro's profitability and earnings visibility.
Risks
We rate Wipro Low Risk which is inline with our quantitative risk-rating system,
which tracks 260-day historical share price volatility. Key downside risks that
could cause shares to fall below our target price include: (1) an extended
slowdown in the US/Global economy; and (2) any significant appreciation of the
rupee against the USD/EUR/GBP.

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