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INFOSYS TECHNOLOGIES
Performance belies expectations
Performance belies expectation: Volume growth lowest in five quarters
Infosys Technologies (Infosys) reported a shockingly disappointing performance
with volume growth being just 3.1% Q-o-Q, the lowest in the past five quarters
(since the sector started recovering). Revenues, at INR 71.1 bn, and net profit,
at INR 17.8 bn, were exactly in line with our expectation, but lower than the
Street’s. Offshore pricing rose 1.4% Q-o-Q in constant currency, after declining
for eight quarters, as it managed to roll back discounts offered during the
slowdown and due to higher revenue share from fixed price projects. EBITDA
margins, at 33.2%, were stable as higher pricing and increased product
revenues countered the pressure arising from INR appreciating against USD.
Medium-term softness due to client specific issues
Infosys’ near-term muted business performance, in our view, is probably due to
client specific issues. We believe, Infosys is walking away from deals from its top
clients that are not meeting its threshold price/margin criteria. While revenue
share from the top client was stable, contribution from top 10 clients reduced
100bps, to 25.7%. We were, however, surprised by the company’s unusually
proactive prediction on FY12 revenue growth of 18-20% based on its view that it
will be a ‘normal year’. This seems to indicate that it is experiencing muted
growth only in the medium term due to client-specific issues and that it expects
growth to improve in FY12.
Focus back on pricing
Infosys’ onsite pricing has been rising for the past five quarters, but offshore
pricing has been declining. In Q3FY11, offshore pricing rose 1.4% Q-o-Q in
constant currency, after declining for eight quarters. The company was able to
roll back discounts offered to some clients during the downturn. It has also
managed to raise prices on certain projects (discretionary in nature), as there is
limited competition. We believe, given the robust demand environment, Infosys
is focused on better priced contracts instead of chasing volumes.
Outlook and valuations: Expectations need to cool off; ‘HOLD’
Infosys, after underperforming TCS for nearly 18 months until November 2010,
outperformed in the past two months due to expectation that earnings upgrade
will catch up with that of TCS. We believe, the Q3FY11 performance and Q4FY11
guidance will preclude upgrade in forecasts for FY12 in the near-term. Thus, at
21.8x FY12E earnings, we maintain ‘HOLD/ Sector performer’ on the stock.
Lowest offshore volume growth since recovery
Infosys reported just 3.1% Q-o-Q volume growth in Q3FY11. The Street expected
performance in the December 2010 quarter to be similar to that in the September 2010
quarter (7.2% Q-o-Q), except for the few extra holidays based on management
commentary. Thus, the muted growth in Q3FY11 was disappointing. Also, its guidance
for Q4FY11 of 2% Q-o-Q revenue growth (in USD) suggests that challenges could
persist.
Client-specific issues may be impacting growth
Infosys indicated that revenue growth in FY12 could be ~18-20%, which is surprising
given that it typically issues guidance only for the current year. This is despite the
company reporting muted performance in Q3FY11 and issuing revenue growth guidance
of just 2% Q-o-Q for Q4FY11. Revenue contribution from its top 10 clients reduced to
25.7% in Q3FY11 from 26.7% in the previous quarter. Infosys’ confidence that FY12
would be a ‘normal year’, despite the likely muted performance in H2FY11, makes us
believe that its near-term growth is being impacted due to client-specific issues, which it
expects to tide over in FY12.
We believe, as the demand environment is robust, Infosys is choosing projects which are
meeting its higher price/margin criteria. In Q3FY11, offshore pricing increased by 1.4%
Q-o-Q in constant currency terms, after declining for eight quarters. While part of the
reported pricing increase is due to higher revenue share from fixed price projects, we
understand that Infosys is able to roll back price discounts offered to a few clients during
the downturn.
Key highlights
• Reported revenues of USD 1,585 mn (up 5.9% Q-o-Q) were in line with our
estimates, while slightly below the Street’s estimate (USD 1,592 mn). This 5.9%
growth was driven by volume growth of 3.1% in IT services.
• Gross margins and EBITDA margins were flat at 45.8% and 33.2%, respectively. The
company was able to offset the currency impact of (1.5%) by price increase of 1.6%,
which aided in sustaining margins Q-o-Q.
• Net profits were at INR 17.8 bn (consensus at INR18.2bn), up 2.5% Q-o-Q, partly
aided by higher other income. Net margin for the quarter stood at 25.0% (flat Q-o-
Q).
• Dollar revenue guidance and EPS (INR) upped for FY11: Infosys revised its
dollar revenue guidance to USD 6.04-6.06 bn from USD 5.95-6.00 bn, which implies
revenue growth of 26% over FY10. It also revised its FY11 EPS guidance to INR
118.7-118.9.
• Tepid Q4 guidance: Infosys has guided next quarter’s revenue to be at USD 1,601–
1,617 mn, implying sequential growth of 1.0-2.0%.
• Healthy client addition continues: New client addition of 40 during the quarter
was impressive. The total active client count now stands at 612 (against 592 in the
previous quarter).
• Muted performance across client categories: Infosys’ top clients grew 3.7% Q-o-
Q (in USD). Growth in top 10 and beyond top 10 clients was 2.0% and 7.4%,
respectively, during the quarter.
• Pricing sees an uptick: In constant currency, blended pricing was up 0.5% Q-o-Q
for the quarter. Offshore grew 1.4% after declining for the past eight quarters, while
onsite rose 0.2%, Q-o-Q.
• Utilisation cools off: Including trainees, utilisation was down 170bps Q-o-Q and is
now at 72.6%; utilisation (ex trainees) followed the same trend and is now at 80.7%
(down 50bps), Q-o-Q. The quarterly annualised attrition has declined to 18.8% from
23.1% last quarter.
• Growth led by manufacturing and BFSI: In constant currency, manufacturing
and BFSI grew 8.6% and 7.1%, respectively, Q-o-Q, whereas retail was up 5.8%.
Telecom reported Q-o-Q decline of 3.9% in constant currency, against growth of
2.2% last quarter
• Horizontals: PES and consulting grew 10.2% and 6.4%, respectively. BPO reported
sequential growth of 5.9% (growth of 8.2% last quarter
• Geographical split: Growth was seen across geographies, with North America
(4.2%), India (11.0%) and ROW (16.0%) posting strong growth during the quarter
on reported basis. Europe too showed sequential growth of 5.9%.
• Net addition: The trend of strong net addition continued with 5,311 employees
added during the quarter, taking the total employee count to 127,779.
• Hedge position: Total outstanding hedge position has increased from USD 556 mn
to USD 585 mn in the current quarter.
• Total cash and equivalents in hand currently stand at USD 3.6 bn.
• DSO stands at 62 (63 in Q2FY11) during the quarter.
Company Description
Infosys is the second-largest IT services company in India providing consulting and IT
services to clients globally. It is also among the fastest growing IT services organization
in the world and a leader in the offshore services space with a pioneer in Global delivery
model. Infosys provides business consulting, application development and maintenance
and engineering services to 590 active clients spread across Banking, Financial Services,
Insurance, Retail, Manufacturing, and Utilities verticals and 50 countries. The company
has also its own proprietary core banking software - Finacle used by some of the leading
banks in India, Middle East, Africa and Europe. Infosys’ total employee force stands at
127,779 and the company’s TTM revenues stood at INR 262.0 bn (USD 5.7 bn).
Investment Theme
Infosys is known for its excellent project execution skills and is one of best sales and
marketing engine, which makes it the most preferred tier 1 vendor. With rapidly
increasing numbers of service lines and domain capabilities, Infosys has readied itself for
multiple possible points of initiating and growing client engagements most profitably. The
recent push has been to delink the revenue and headcount linkage and moving away
from revenues to over 33% in next 5-7 years. The company has also demonstrated its
ability to engage with larger client organizations and winning increasing proportion of
their wallet share with focused farming approach. Infosys’ growth over FY02-08 clearly
reflects its abilities to benefit from the improving macro environment, however we
believe a greater risk taking approach will be required to increasing market share.
Key Risks
Key risks to our investment theme include – IT spending picks up further and Infosys
sheds its conservatism and bids aggressively for large deals.
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