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Infosys Technologies
Earnings momentum to continue
We expect continued earnings momentum for our top pick Infosys, given its
increasing presence/focus in growth areas, 'must-have' account additions and
exposure to underpenetrated geographies, in addition to its improving wallet
share in large deals. We initiate coverage at Buy, target price Rs3,750.
Convinced by Infosys’ growth strategies
We are convinced that Infosys’ growth strategies are appropriate, as they not only
encompass what it does best – ie mining existing clients – but also focus on underpenetrated
opportunities such as what it considers as ‘must-have’ account additions and spearheading
the big markets of Europe beyond the UK. Moreover, with an increasing wallet share in large
deals (~US$174bn worth of IT/BPO outsourcing renewals due over the next two years), we
expect Infosys to continue to demonstrate robust revenue growth. We expect Infosys to take
a more confident stance in its FY12 guidance (due in April 2011). We forecast a USD
revenue CAGR of 24% for FY11-13.
Strong presence in high-growth areas
Our macro analysis indicates that most vendors under our coverage are likely to see high
growth in discretionary spending, BFSI (banking, financial services and insurance) and retail
beyond CY10. Considering Infosys’ relatively high focus on these areas, and its improving
positioning within manufacturing, its revenue growth potential appears high and diversified.
We see relatively low risk to earnings compared with its peers.
Low risk to margins and earnings growth
We not only expect industry-leading revenue growth in the coming years for Infosys, we also
believe it can outperform its peers in managing margins, given greater headroom. With its tax
rate near peak levels and given high operational growth, we forecast an EPS CAGR of about
23% for Infosys for FY11-13.
Initiate with Buy; valuations look reasonable with high earnings growth potential
We forecast an EPS CAGR of about 23% for FY11-13 and base our target price of Rs3,750
on a PE of about 20.5x FY13F EPS (similar to the stock’s long-term average). Our target
price implies a target EV/EBITDA multiple of about 14x FY13F EBITDA (vs the long-term
average of about 15x) with our forecast EBITDA CAGR of 21% over FY11-13.
The basics
Catalysts for share price performance
We expect the key near-term catalysts to be:
CY11 client IT budget finalisation, with higher yoy growth in outsourcing and offshoring. We
expect Infosys to gain the most among our coverage universe, considering its focus in highgrowth
services/verticals including enterprise solutions, BFSI and retail.
Cognizant’s guidance for CY11 (due in February 2011) and Infosys’s guidance for FY12 (due
in April 2011). While building in its typical conservatism, we expect Infosys to take a more
confident stance on FY12 guidance.
Renewal of large outsourcing contracts worth US$174bn over eight quarters starting 4QCY10
(about US$90bn renewals due over 4QCY10-3QCY11). This should keep Infosys’s deal
pipeline strong, considering its increasing wallet share (ie share of a customer’s IT spend) in
large deals.
Faster growth in discretionary spending, where Infosys stands to benefit more than its peers,
because of a higher contribution to revenues but also given its domain expertise across
practises.
Pick-up in demand momentum from Europe (in addition to continuing momentum in the US)
with potential for greater outsourcing. Within Europe (excluding British Telecom, where
revenues growth remains a challenge) Infosys’ traction is increasing.
Earnings momentum
We expect earnings momentum to remain high in the coming years, given the company’s
considerable presence in areas (including BFSI, retail and discretionary spend) that are poised for
robust growth. We expect Infosys to not only register above-industry-average revenue growth, but
also to outperform its peers in terms of managing margin pressure, given greater headroom.
We assume USD revenue, INR EBITDA and INR normalised EPS CAGRs of 24%, 21% and 23%,
respectively, over FY11-13, the highest among the large-cap peers we cover.
Valuation and target price
We value Infosys on forward PE, based on earnings growth potential for FY11-13F and the
historical forward PE range. We initiate coverage with Buy with a target price of Rs3,750, offering
21% upside potential. With an EPS CAGR of about 23% for FY11-13F, our target PE of about
20.5x FY13F EPS (similar to its long-term average) looks reasonable. Our target price implies a
target EV/EBITDA multiple of about 14xFY13F EBITDA vs the long-term historical average of
about 15x and our forecast of EBITDA CAGR of 21% for FY11-13F.
How we differ from consensus
Our FY12 and FY13 EPS forecasts are largely in line with Bloomberg consensus. We do not
exclude the possibility of further upside potential to our EPS forecasts.
Risks to central scenario
Slower-than-expected growth in discretionary spending should affect Infosys more than peers,
as we estimate discretionary services account for >55% of Infosys’ revenues.
Any further deterioration in the macro environment in western economies, as the US and
Europe contribute >85% of revenues.
Any sharp appreciation of INR vs the USD would be significantly negative for revenues and
hence for margins/EPS, as would a sharp depreciation in EUR, GBP and AUD vs the USD.
Fiscal austerity and resulting protectionism measures in western economies.
Convincing growth strategies
We believe Infosys’ growth strategies, which include ‘must-have’ account additions and
spearheading underpenetrated opportunities, will lead to greater and more diversified
revenue growth in the coming years.
We are convinced that Infosys’ growth strategies are appropriate, as they not only encompass
what it does best – ie mining existing clients – but also focus on underpenetrated opportunities
such as ‘must-have’ account additions and spearheading the big markets of Europe beyond the
UK. Moreover, with increasing wallet share in large deal wins (about US$174bn worth of
outsourcing renewals due over the next two years) and greater margin flexibility, we expect
Infosys to continue to demonstrate robust revenue growth. We forecast a USD revenue CAGR of
24% for FY11-13.
‘Must-have’ account addition strategy
As they grow in size, Indian IT large caps must have client-mining strategies in place to ensure
consistently high and profitable growth. We believe this parameter is of utmost importance given
the increasing revenue base and competitive pressure. Our analysis indicates that Infosys is a
clear leader in this strategy. Besides its ability to mine existing clients with end-to-end service
offerings, its recent focus on adding ‘must-have’ new accounts to its portfolio should lead to
greater visibility in revenue growth vs peers
Infosys has consistently led the pack in client mining, with a CAGR of 21.1% in average revenue
per client and an active client CAGR of just 7.6% over FY03-10 (30.3% consolidated revenue
CAGR during the same period). There was a 7.9% CAGR in US Fortune 500 client base over
FY05-10, but an increasing focus on adding quality clients lifted this growth rate to 27% in FY10
alone, to 126 US Fortune 500 clients, albeit still low out of the company’s total US client base of
>300. Infosys has >145 Global Fortune 500 clients at the end of 3QFY11.
Spearheading big European markets beyond the UK
Infosys is increasingly focusing on penetrating other big markets beyond the UK within Europe.
These are still not penetrated by Indian IT firms in terms of outsourcing/offshoring, despite
services spend in countries like Germany and France not being materially lower than that of the
UK .
These markets offer their own cultural challenges, and to address these Infosys has already
appointed local heads and is consequently seeing higher deal RFPs (requests for proposal).
Other vendors employ the same strategies to tap these markets; however, we believe Infosys’
positioning in Europe is better suited to the needs of these markets. By vertical, the largest
services spend in Germany and France is in manufacturing, with its overall contribution as high as
26% of total services spend in these countries (vs 21.5% for Western Europe). Manufacturing
contributed about 19% of Infosys’ consolidated revenues, but 32% of Europe revenues in
2QFY11.
With a higher services spend in the manufacturing vertical within the non-UK markets of Western
Europe which have a propensity to use packaged software, vendors with high domain expertise in
enterprise solutions are likely to be the preferred for large outsourcing deals in these markets.
Here again, Infosys’ positioning is strong, where consulting and package implementation
revenues contribute as much as 38% of total European revenues (in 2QFY11, vs a consolidated
average of about 26%).
Considering these facts, we believe Infosys’ positioning in Europe is better than some of its peers,
and we believe that its greater focus of late on penetrating new markets within Europe is likely to
generate higher payoffs over the longer term.
Strategy already bearing fruit: non-UK revenues accelerating
Despite an overall muted revenue performance by Infosys, as well as the industry, in the past six
to eight quarters within Europe (besides recessionary pressure, lower revenues from British
Telecom [BT] also affected European revenue growth at Infosys), Infosys’ performance in the non-
UK European market has been impressive vs peers. Even Germany and France have seen
growth accelerate, albeit from a low base for Infosys.
Strong presence in high-growth areas
We believe growth in discretionary spending, BFSI and retail is likely to accelerate in CY11
for most vendors under our coverage. However, we expect Infosys to gain the most due to
its relatively high focus on these services/verticals.
Discretionary spending set to rise
Our macro check indicates that business confidence among US CEOs is rising. With most
productivity gains for US corporates being exhausted, we believe they will need to invest in
expansion, which may drive new project IT spending. Therefore, we expect discretionary spending
in the US to gather momentum beyond CY10. However, we are cautious on discretionary IT
spending growth within Europe, as corporates are fearful of the impact of austerity measures and
the sovereign debt crisis in the European periphery.
Based on our analysis, Infosys derives >55% of its revenues from discretionary spending, which is
much higher than peers.
Indian IT services growth within the discretionary portfolio over the past 12-13 quarters has been
driven largely by enterprise solutions and consulting rather than development spend (see Chart
10). This trend suggests clients are now opting for more customised packaged software than
customised application development. Licence revenue growth at Oracle and SAP is rising (yoy
growth inching up to the high double digits), and we therefore expect demand for package
implementation services to be sustained (as this typically lags licence sales by two to three
quarters).
Infosys and TCS: BFSI, retail account for much of the revenue mix
As discussed in our sector note, our macro analysis indicates that BFSI, retail and, to some
extent, manufacturing, are likely to offer improved growth opportunities beyond CY10 for Indian IT
firms, with most global companies operating in these verticals likely to register growth in high
single or double digits in CY11-12F
Besides a higher proportion of revenues coming from high-growth verticals (including BFSI and
retail), Infosys’ increasingly strong positioning within manufacturing not only enhances its growth
potential but also diversifies its revenue growth, and hence reduces the risk to earnings.
Relatively low risk to earnings
We expect Infosys to not only register leading growth in revenues but also in net earnings
in the coming years, with its relatively high scope to manage margin pressure vs peers.
Therefore, we believe that risk to Infosys’s earnings growth is lower than that of its peers.
Billing rate woes behind us
Recessionary pressures and cross-currency volatility resulted in significant downward pressure on
pricing for Infosys after FY08. Current offshore pricing is 6-7% lower than it was pre-recession (in
late CY07) for Infosys in constant currency terms. However, Infosys successfully recouped some
of the discounts offered during the recession, and this should begin to become apparent in pricing
in the coming quarters . Besides this, we believe it has historically been successful in not only
driving outsourcing of enterprise solutions but in getting follow-up business, the combination of
which is more profitable and consequently boosts margins. With a potential revival in discretionary
spend, we believe the worst of the billing rate decline is behind us. We estimate constant currency
pricing will rise 1-2% pa for FY11-13.
Headroom in other margin levers is greater
We believe Infosys still has greater scope to manage margin pressures than its peers, despite not
compromising on investments.
Utilisation rates (including trainees), fixed price and offshoring lower than most peers
Infosys’ utilisation rates (including trainees) are lower than those at peers, despite improving in
recent quarters (albeit in 3QFY11, Infosys’ rate declined to 72.6% from 74.3% in 2QFY11), and
are still below its all-time high of 78% achieved in FY03 (year of recovery post-recession impact in
FY02). While we expect a higher intake of freshers to put pressure on utilisation rates, the higher
base and increasing focus on non-linearity (where revenue growth is faster than headcount
additions) would result into new norms for utilisation rates over the medium to long term.
Headroom in other margin levers, including fixed prices and offshoring, is higher for Infosys than
for most peers.
Employee pyramid
Infosys is a leader in managing its employee pyramid, with a state-of-the-art training
infrastructure. However, the proportion of employees with less than three years of experience is
now close to 10-year historical lows. Going into CY11, we believe most vendors have a good
degree of certainty regarding their client’s budget and likely ramp-up in outsourcing and
offshoring. This should result in better planning for freshers recruitment and more productive
management of the bench. Therefore, we expect an improving proportion of <3-year employees
from FY12, which should lead to a big margin tailwind for Infosys
Initiate with Buy; valuations look reasonable
We expect Infosys to lead its peers in terms of revenue and EPS growth over FY11-13, and
we see lower risk to its earnings growth. We initiate coverage at Buy, with Infosys being
our top pick in the sector.
We expect substantial earnings momentum for Infosys over the coming years, with its relatively
high presence in areas (including BFSI, retail and discretionary spending) poised for strong
growth. We are also convinced by its growth strategies, which not only encompass what it does
best (i.e. mining the potential client), but also increasingly focuses on less penetrated
opportunities and increasing the company’s wallet share in large deals. In addition, we believe its
headroom in various margin levers – including utilisation rates, offshoring, fixed prices etc – is
greater than for some of the peers.
Infosys – initiate coverage with a Buy recommendation
With lower risk to its industry-leading earnings growth, we initiate coverage on Infosys at Buy with
a target price of Rs3,750 offering 21% upside potential. With an EPS CAGR of about 23% for
FY11-13F, our target PE of about 20.5x FY13F EPS (similar to its historical long-term average)
seems reasonable. Our target price implies an EV/EBITDA multiple of about 14x FY13F EBITDA
(vs the historical long-term average of about 15x) with an EBITDA CAGR of about 21% for FY11-
13F.
Management team
Infosys Technologies is one of the leading IT service companies in India, with founder promoters
holding a16% equity stake. It is has set the benchmark for the IT industry as well as Indian
markets for its high corporate governance. On the back of consistent high revenue growth over
the years, Infosys has become India’s second-largest IT services company, with 3QFY11
annualised revenues of more than US$6.3bn. Its operations are managed by a strong team of
professionals. Besides the top management team, Infosys, on an ongoing basis, has created a
strong second line of management to take over the reins from top managers after their retirement.
Infosys leads its peers in terms of cash generation. Despite its conservative utilisation of its cash
pile over the years, it has been consistent in the payment of cash dividends. It also announces a
special dividend once every two to three years in addition to the yearly dividend. The FY09/FY10
dividend payout ratio (excluding special dividends) was around 23%.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Infosys Technologies
Earnings momentum to continue
We expect continued earnings momentum for our top pick Infosys, given its
increasing presence/focus in growth areas, 'must-have' account additions and
exposure to underpenetrated geographies, in addition to its improving wallet
share in large deals. We initiate coverage at Buy, target price Rs3,750.
Convinced by Infosys’ growth strategies
We are convinced that Infosys’ growth strategies are appropriate, as they not only
encompass what it does best – ie mining existing clients – but also focus on underpenetrated
opportunities such as what it considers as ‘must-have’ account additions and spearheading
the big markets of Europe beyond the UK. Moreover, with an increasing wallet share in large
deals (~US$174bn worth of IT/BPO outsourcing renewals due over the next two years), we
expect Infosys to continue to demonstrate robust revenue growth. We expect Infosys to take
a more confident stance in its FY12 guidance (due in April 2011). We forecast a USD
revenue CAGR of 24% for FY11-13.
Strong presence in high-growth areas
Our macro analysis indicates that most vendors under our coverage are likely to see high
growth in discretionary spending, BFSI (banking, financial services and insurance) and retail
beyond CY10. Considering Infosys’ relatively high focus on these areas, and its improving
positioning within manufacturing, its revenue growth potential appears high and diversified.
We see relatively low risk to earnings compared with its peers.
Low risk to margins and earnings growth
We not only expect industry-leading revenue growth in the coming years for Infosys, we also
believe it can outperform its peers in managing margins, given greater headroom. With its tax
rate near peak levels and given high operational growth, we forecast an EPS CAGR of about
23% for Infosys for FY11-13.
Initiate with Buy; valuations look reasonable with high earnings growth potential
We forecast an EPS CAGR of about 23% for FY11-13 and base our target price of Rs3,750
on a PE of about 20.5x FY13F EPS (similar to the stock’s long-term average). Our target
price implies a target EV/EBITDA multiple of about 14x FY13F EBITDA (vs the long-term
average of about 15x) with our forecast EBITDA CAGR of 21% over FY11-13.
The basics
Catalysts for share price performance
We expect the key near-term catalysts to be:
CY11 client IT budget finalisation, with higher yoy growth in outsourcing and offshoring. We
expect Infosys to gain the most among our coverage universe, considering its focus in highgrowth
services/verticals including enterprise solutions, BFSI and retail.
Cognizant’s guidance for CY11 (due in February 2011) and Infosys’s guidance for FY12 (due
in April 2011). While building in its typical conservatism, we expect Infosys to take a more
confident stance on FY12 guidance.
Renewal of large outsourcing contracts worth US$174bn over eight quarters starting 4QCY10
(about US$90bn renewals due over 4QCY10-3QCY11). This should keep Infosys’s deal
pipeline strong, considering its increasing wallet share (ie share of a customer’s IT spend) in
large deals.
Faster growth in discretionary spending, where Infosys stands to benefit more than its peers,
because of a higher contribution to revenues but also given its domain expertise across
practises.
Pick-up in demand momentum from Europe (in addition to continuing momentum in the US)
with potential for greater outsourcing. Within Europe (excluding British Telecom, where
revenues growth remains a challenge) Infosys’ traction is increasing.
Earnings momentum
We expect earnings momentum to remain high in the coming years, given the company’s
considerable presence in areas (including BFSI, retail and discretionary spend) that are poised for
robust growth. We expect Infosys to not only register above-industry-average revenue growth, but
also to outperform its peers in terms of managing margin pressure, given greater headroom.
We assume USD revenue, INR EBITDA and INR normalised EPS CAGRs of 24%, 21% and 23%,
respectively, over FY11-13, the highest among the large-cap peers we cover.
Valuation and target price
We value Infosys on forward PE, based on earnings growth potential for FY11-13F and the
historical forward PE range. We initiate coverage with Buy with a target price of Rs3,750, offering
21% upside potential. With an EPS CAGR of about 23% for FY11-13F, our target PE of about
20.5x FY13F EPS (similar to its long-term average) looks reasonable. Our target price implies a
target EV/EBITDA multiple of about 14xFY13F EBITDA vs the long-term historical average of
about 15x and our forecast of EBITDA CAGR of 21% for FY11-13F.
How we differ from consensus
Our FY12 and FY13 EPS forecasts are largely in line with Bloomberg consensus. We do not
exclude the possibility of further upside potential to our EPS forecasts.
Risks to central scenario
Slower-than-expected growth in discretionary spending should affect Infosys more than peers,
as we estimate discretionary services account for >55% of Infosys’ revenues.
Any further deterioration in the macro environment in western economies, as the US and
Europe contribute >85% of revenues.
Any sharp appreciation of INR vs the USD would be significantly negative for revenues and
hence for margins/EPS, as would a sharp depreciation in EUR, GBP and AUD vs the USD.
Fiscal austerity and resulting protectionism measures in western economies.
Convincing growth strategies
We believe Infosys’ growth strategies, which include ‘must-have’ account additions and
spearheading underpenetrated opportunities, will lead to greater and more diversified
revenue growth in the coming years.
We are convinced that Infosys’ growth strategies are appropriate, as they not only encompass
what it does best – ie mining existing clients – but also focus on underpenetrated opportunities
such as ‘must-have’ account additions and spearheading the big markets of Europe beyond the
UK. Moreover, with increasing wallet share in large deal wins (about US$174bn worth of
outsourcing renewals due over the next two years) and greater margin flexibility, we expect
Infosys to continue to demonstrate robust revenue growth. We forecast a USD revenue CAGR of
24% for FY11-13.
‘Must-have’ account addition strategy
As they grow in size, Indian IT large caps must have client-mining strategies in place to ensure
consistently high and profitable growth. We believe this parameter is of utmost importance given
the increasing revenue base and competitive pressure. Our analysis indicates that Infosys is a
clear leader in this strategy. Besides its ability to mine existing clients with end-to-end service
offerings, its recent focus on adding ‘must-have’ new accounts to its portfolio should lead to
greater visibility in revenue growth vs peers
Infosys has consistently led the pack in client mining, with a CAGR of 21.1% in average revenue
per client and an active client CAGR of just 7.6% over FY03-10 (30.3% consolidated revenue
CAGR during the same period). There was a 7.9% CAGR in US Fortune 500 client base over
FY05-10, but an increasing focus on adding quality clients lifted this growth rate to 27% in FY10
alone, to 126 US Fortune 500 clients, albeit still low out of the company’s total US client base of
>300. Infosys has >145 Global Fortune 500 clients at the end of 3QFY11.
Spearheading big European markets beyond the UK
Infosys is increasingly focusing on penetrating other big markets beyond the UK within Europe.
These are still not penetrated by Indian IT firms in terms of outsourcing/offshoring, despite
services spend in countries like Germany and France not being materially lower than that of the
UK .
These markets offer their own cultural challenges, and to address these Infosys has already
appointed local heads and is consequently seeing higher deal RFPs (requests for proposal).
Other vendors employ the same strategies to tap these markets; however, we believe Infosys’
positioning in Europe is better suited to the needs of these markets. By vertical, the largest
services spend in Germany and France is in manufacturing, with its overall contribution as high as
26% of total services spend in these countries (vs 21.5% for Western Europe). Manufacturing
contributed about 19% of Infosys’ consolidated revenues, but 32% of Europe revenues in
2QFY11.
With a higher services spend in the manufacturing vertical within the non-UK markets of Western
Europe which have a propensity to use packaged software, vendors with high domain expertise in
enterprise solutions are likely to be the preferred for large outsourcing deals in these markets.
Here again, Infosys’ positioning is strong, where consulting and package implementation
revenues contribute as much as 38% of total European revenues (in 2QFY11, vs a consolidated
average of about 26%).
Considering these facts, we believe Infosys’ positioning in Europe is better than some of its peers,
and we believe that its greater focus of late on penetrating new markets within Europe is likely to
generate higher payoffs over the longer term.
Strategy already bearing fruit: non-UK revenues accelerating
Despite an overall muted revenue performance by Infosys, as well as the industry, in the past six
to eight quarters within Europe (besides recessionary pressure, lower revenues from British
Telecom [BT] also affected European revenue growth at Infosys), Infosys’ performance in the non-
UK European market has been impressive vs peers. Even Germany and France have seen
growth accelerate, albeit from a low base for Infosys.
Strong presence in high-growth areas
We believe growth in discretionary spending, BFSI and retail is likely to accelerate in CY11
for most vendors under our coverage. However, we expect Infosys to gain the most due to
its relatively high focus on these services/verticals.
Discretionary spending set to rise
Our macro check indicates that business confidence among US CEOs is rising. With most
productivity gains for US corporates being exhausted, we believe they will need to invest in
expansion, which may drive new project IT spending. Therefore, we expect discretionary spending
in the US to gather momentum beyond CY10. However, we are cautious on discretionary IT
spending growth within Europe, as corporates are fearful of the impact of austerity measures and
the sovereign debt crisis in the European periphery.
Based on our analysis, Infosys derives >55% of its revenues from discretionary spending, which is
much higher than peers.
Indian IT services growth within the discretionary portfolio over the past 12-13 quarters has been
driven largely by enterprise solutions and consulting rather than development spend (see Chart
10). This trend suggests clients are now opting for more customised packaged software than
customised application development. Licence revenue growth at Oracle and SAP is rising (yoy
growth inching up to the high double digits), and we therefore expect demand for package
implementation services to be sustained (as this typically lags licence sales by two to three
quarters).
Infosys and TCS: BFSI, retail account for much of the revenue mix
As discussed in our sector note, our macro analysis indicates that BFSI, retail and, to some
extent, manufacturing, are likely to offer improved growth opportunities beyond CY10 for Indian IT
firms, with most global companies operating in these verticals likely to register growth in high
single or double digits in CY11-12F
Besides a higher proportion of revenues coming from high-growth verticals (including BFSI and
retail), Infosys’ increasingly strong positioning within manufacturing not only enhances its growth
potential but also diversifies its revenue growth, and hence reduces the risk to earnings.
Relatively low risk to earnings
We expect Infosys to not only register leading growth in revenues but also in net earnings
in the coming years, with its relatively high scope to manage margin pressure vs peers.
Therefore, we believe that risk to Infosys’s earnings growth is lower than that of its peers.
Billing rate woes behind us
Recessionary pressures and cross-currency volatility resulted in significant downward pressure on
pricing for Infosys after FY08. Current offshore pricing is 6-7% lower than it was pre-recession (in
late CY07) for Infosys in constant currency terms. However, Infosys successfully recouped some
of the discounts offered during the recession, and this should begin to become apparent in pricing
in the coming quarters . Besides this, we believe it has historically been successful in not only
driving outsourcing of enterprise solutions but in getting follow-up business, the combination of
which is more profitable and consequently boosts margins. With a potential revival in discretionary
spend, we believe the worst of the billing rate decline is behind us. We estimate constant currency
pricing will rise 1-2% pa for FY11-13.
Headroom in other margin levers is greater
We believe Infosys still has greater scope to manage margin pressures than its peers, despite not
compromising on investments.
Utilisation rates (including trainees), fixed price and offshoring lower than most peers
Infosys’ utilisation rates (including trainees) are lower than those at peers, despite improving in
recent quarters (albeit in 3QFY11, Infosys’ rate declined to 72.6% from 74.3% in 2QFY11), and
are still below its all-time high of 78% achieved in FY03 (year of recovery post-recession impact in
FY02). While we expect a higher intake of freshers to put pressure on utilisation rates, the higher
base and increasing focus on non-linearity (where revenue growth is faster than headcount
additions) would result into new norms for utilisation rates over the medium to long term.
Headroom in other margin levers, including fixed prices and offshoring, is higher for Infosys than
for most peers.
Employee pyramid
Infosys is a leader in managing its employee pyramid, with a state-of-the-art training
infrastructure. However, the proportion of employees with less than three years of experience is
now close to 10-year historical lows. Going into CY11, we believe most vendors have a good
degree of certainty regarding their client’s budget and likely ramp-up in outsourcing and
offshoring. This should result in better planning for freshers recruitment and more productive
management of the bench. Therefore, we expect an improving proportion of <3-year employees
from FY12, which should lead to a big margin tailwind for Infosys
Initiate with Buy; valuations look reasonable
We expect Infosys to lead its peers in terms of revenue and EPS growth over FY11-13, and
we see lower risk to its earnings growth. We initiate coverage at Buy, with Infosys being
our top pick in the sector.
We expect substantial earnings momentum for Infosys over the coming years, with its relatively
high presence in areas (including BFSI, retail and discretionary spending) poised for strong
growth. We are also convinced by its growth strategies, which not only encompass what it does
best (i.e. mining the potential client), but also increasingly focuses on less penetrated
opportunities and increasing the company’s wallet share in large deals. In addition, we believe its
headroom in various margin levers – including utilisation rates, offshoring, fixed prices etc – is
greater than for some of the peers.
Infosys – initiate coverage with a Buy recommendation
With lower risk to its industry-leading earnings growth, we initiate coverage on Infosys at Buy with
a target price of Rs3,750 offering 21% upside potential. With an EPS CAGR of about 23% for
FY11-13F, our target PE of about 20.5x FY13F EPS (similar to its historical long-term average)
seems reasonable. Our target price implies an EV/EBITDA multiple of about 14x FY13F EBITDA
(vs the historical long-term average of about 15x) with an EBITDA CAGR of about 21% for FY11-
13F.
Management team
Infosys Technologies is one of the leading IT service companies in India, with founder promoters
holding a16% equity stake. It is has set the benchmark for the IT industry as well as Indian
markets for its high corporate governance. On the back of consistent high revenue growth over
the years, Infosys has become India’s second-largest IT services company, with 3QFY11
annualised revenues of more than US$6.3bn. Its operations are managed by a strong team of
professionals. Besides the top management team, Infosys, on an ongoing basis, has created a
strong second line of management to take over the reins from top managers after their retirement.
Infosys leads its peers in terms of cash generation. Despite its conservative utilisation of its cash
pile over the years, it has been consistent in the payment of cash dividends. It also announces a
special dividend once every two to three years in addition to the yearly dividend. The FY09/FY10
dividend payout ratio (excluding special dividends) was around 23%.
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