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Infosys Technologies (INFO)
Technology
Wait for the perfect quarter continues. Infosys’ quality and quantum of 3QFY11
performance was weaker than expected. Weak volume growth, high attrition and
modest growth guidance were significant dampeners. Without shifting focus from
weak performance, volatility in quarterly performance would be a common occurrence;
FY2011E performance is commendable, in our view. FY2012E would be a blockbuster
year for Tier 1; expect Infosys to gain. We marginally lower our estimates and TP. BUY.
3QFY11 performance modest; volume growth lower than guidance
Infosys reported 6% sequential revenue growth to US$1,585 mn, 1% lower than our expectation.
Constant currency revenue growth was modest at 4.7%. Volumes growth was a disappointing
3.1% and missed the lower end of the company guidance. Continued weakness in
communication service provider (CSP) vertical and weak performance from others segments
disappoints. Note that performance for 3QFY11 may have been helped by product resale as a part
of either products or SI business. Net income of Rs17.8 bn was 2.2% lower than our estimate.
CSP vertical has grown by a marginal 2.2% YTD as against 26.5% for the company overall. More
important, Infosys has ceded leadership in this vertical to TCS and Tech Mahindra; this is contrary
to historical trend of dominating and extending leadership in areas of strength. Nonetheless, we
expect the recent marquee wins in this vertical to make up for recent losses.
4QFY11E guidance weak but does it really matter?
Infosys has guided for a weak 1-2% US$ revenue growth for Mar ’11 quarter. However,
management commentary that it has adopted a cautious stance based on still ongoing client
budget discussions and uncertain macro environment indicates that the guidance should be taken
with a pinch of salt. We emphasize that Infosys’ guidance provides indication on minimum
revenue growth but is of little utility in setting realistic growth expectations.
FY2012E could be a blockbuster year for the Tier 1s, including Infosys
We believe FY2012E has the potential to be a 30%+ constant currency revenue growth year for
the top-3 Indian IT services companies on the back of – (1) broad-based IT spend revival, (2) strong
large deal renewal cycle with greater participation and win rate for the Indian names, (3) sustained
market share gains for offshore pure-plays, (4) continued footprint expansion across un/underpenetrated areas, and (5) pricing uptick. We forecast 27% US$ revenue growth in FY2012E and Rs155 EPS (3.5% downgrade). BUY with a 12-month TP of Rs3,700 (Rs3,800 earlier).
Lead indicators on demand continue to trend in the positive direction
Despite the 3QFY11 expectation miss and a modest 4QFY11E revenue growth guidance
(which we believe is conservative, yet again), we see little reason to change our positive
stance on strong demand momentum for the Indian IT services players. Infosys’ volume
growth in the Dec 2010 quarter was likely impacted by a couple of client-specific issues,
especially in the CSP vertical. We note several positive indicators on demand otherwise,
including
�� Broad-based revenue growth – even as BFSI vertical continues to be strong (+8.3% qoq,
+4.9% excluding products), Infosys reported a strong quarter in the manufacturing
(+9.9% qoq) and retail (+6.7% qoq) verticals as well. We note that these are the three
largest verticals for Infosys (and among the top 4 for the industry including Telecom)
contributing 70% to Infosys’ revenues.
�� Clear signs of pick-up in discretionary spending – reflected in strong quarter of growth for
Consulting/PI (+6.4% qoq), product engineering (+10.2%), application development
(+5.9%) and testing (+5.9%) services.
�� Client buckets continue to show impressive movement. # of US$50 mn accounts went up
by 2 in the quarter to 29 (+7 yoy). # of US$100 mn accounts also increased by 1 qoq and
5 yoy to 11.
�� New account signings strong. Infosys signed 40 new accounts during the quarter; more
importantly, the company indicated that most of these new clients are in the company’s
focus area - F-500/G-2000.
�� Hiring continues to be robust. Gross hiring of 11,067 for the quarter takes YTD gross
hiring to 34,190 and we expect the company to exceed its FY2011E gross hiring guidance
of 40,000. We also note that lateral gross hiring in the quarter at 5,212 is the highest in
the company’s history.
�� Subsidiaries continue to grow strong, with Australia, Consulting, China, and Mexico all
reporting double-digit sequential revenue growth.
�� Management commentary on client IT budgets (‘marginally up with higher allocation for
off-shoring’), FY2012E industry revenue growth (‘high teens’), and deal pipeline (‘robust’)
continues to suggest strong underlying demand environment.
Margins – pricing and employee pyramid key levers for FY2012E
We continue to see Infosys well-positioned to protect profitability in a narrow range in
FY2012E despite likely pressure from another year of high wage hikes in the industry. Our
confidence is based on two key levers – (1) likely pricing improvement, despite Infosys’
‘stable pricing’ stance, and (2) employee pyramid expansion – trainees now form 11.2% of
the IT services technical strength, a multi-year high proportion; in addition, with attrition
starting to trend down and most companies making strong campus offer, we expect
meaningful pyramid expansion in FY2012E. We note that employees with 0-3 years of
experience now form 39.4% of total base, down from levels as high as 59% in the past.
Other details
�� Infosys raised its FY2011E revenue growth guidance to 26% at the upper end versus
25% earlier; Re EPS guidance has been raised to Rs119 versus Rs117 earlier. The
company has built in a Re/US$ rate of 44.71 for 4QFY11E in its guidance. Exhibit 2
depicts details on revised FY2011E guidance.
Attrition trended down to 18.4% on a quarterly annualized basis, though inched up on
an LTM basis to 17.5%.
Infosys increased its hedges outstanding marginally to US$585 mn from US$500 mn at
end-Sep 2010. The company continues to hedge on a short-term basis, consistent with its
policy of hedging for less than two quarters of net cash inflows.
Effective tax rate for the quarter at 27% came in higher than expectations and the
company has guided for a 26.5% ETR for FY2011E, marginally higher than the 26%
guided earlier.
DSO (including unbilled revenues) remained steady at 67 days for the quarter.
Estimate/TP revision
We reduce our EPS estimate for FY2012E by 3.5% to Rs155.2 and for FY2013E by 0.5% to
Rs184.9. Estimate cut is driven by modest cut in revenue as well as margin assumptions. We
note that we continue to expect a strong FY2012E for the Tier-I names and accordingly build
in 26.8% US$ revenue growth for Infosys. Our target price on Infosys stands reduced to
Rs3,700/share versus Rs3,800 earlier, implying a PE multiple of 23.8X FY2012E and 20X
FY2013E EPS.
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