Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Growth or margin leadership?
Revenue growth remains the key to higher stock returns.
Offshore IT vendors have used different business strategies over the past decade.
While Infosys has tried to maintain its premium margins, Cognizant has sought to
remain a growth leader operating at much lower margins. More recently, TCS has
managed bit of both while HCL is trying to replicate Cognizant. Our analysis of stock
performance over the past few years indicates that revenue growth leadership has
consistently triumphed margin leadership in delivering stock returns. The street is
more palatable to lower margins as long as revenue growth remains strong. Volume
growth with stable margin remains the elixir of stock returns in IT Services.
This note analyses Cognizant (proxy for growth leadership) and Infosys’ (proxy for
margin leadership) financials over the past few years and concludes that the drive
for higher revenue growth has helped Cognizant close the gap with Infosys not only
on revenues but also on operating profits. Moreover, Infosys’ inability to re-deploy
its capital more profitably has resulted in significantly higher compression of ROEs
c.f. Cognizant. Expectedly, the street has rewarded Cognizant’s growth leadership
with a much higher return (cum dividends) across every time period in last 7 years.
Thus, historical experience suggests that if Infosys remains focused on maintaining
its margin levels, its stock runs the risk of not only further underperforming
Cognizant but also peers like TCS and HCL who have upped the ante on revenue
growth. At the same time, if Infosys chooses to drop margins to drive above peer
revenue growth, near-term earnings hit could impact stock performance. TCS is our
top pick in the sector over the next 12 months.
Cognizant’s revenue leadership driving better stock returns
Infosys’ margin leadership not helping as much
Cognizant’s focus on market share gain while maintaining a stable lower margin
level has resulted in rapid closing of the revenue gap with Infosys. 6 years back,
Infosys’ revenues were 2.5x Cognizant’s but in the latest quarter, Infosys is ahead
only by ~20% (See Figure 1). Note that neither company has been excessively
acquisitive in this period. In fact, the absolute revenue differential (See Figure 2)
between the two companies in Dec-10 quarter is similar to the Sep-05 quarter
despite the fact that Infosys’ revenues have grown three-fold over this period.
Revenue league tables remain important in IT Services as scale is an important
determinant of invite for new deals. Also, it aids employee hiring and retention.
Faster revenue growth has also helped Cognizant close the gap on operating profit.
Cognizant’s operating profit is now half of Infosys’, up significantly from a quarter,
6 years ago (See Figure 3). In fact, over the last 2 years, Cognizant has added as
much operating profit as Infosys. Note that Cognizant’s lower margins c.f. Infosys
are not just because of Infosys’ higher cost efficiencies. It is as much driven by
Cognizant’s willingness to be flexible to client demands (which drives better
growth), its higher bonus provisioning (which helps retain employees) as by
Infosys’ overall better cost management.
Catch-22 situation for Infosys?
Infosys has two investment futures, both of which rest on a strong 2011, where
sceptical debate is waning, unless cataclysmic macroeconomic events intervene.
However, one of the possible pathways suggests that while 2011 will be a good
year for Infosys on revenue growth, peers could outperform once again on
revenues if Infosys continues to focus on margins. Exit rate for TCS, HCL and
Cognizant is already much more favourable than Infosys. This could potentially hurt
relative multiples further impacting stock performance c.f. peers. Note that barring
Wipro other Tier-1 IT peers have all re-rated c.f. Infosys through the last 18-24
months and some of it is attributable to the slower revenue growth.
The second scenario is a brighter one from a medium to long term perspective but
unfavourable over the next 12-18 months. Infosys reinvents itself, introduces new
services, gets more flexible on deals, breaks the linear equation of revenueemployees
and opens new markets through greater investment in sales &
marketing. This should help drive faster revenue growth. This will invariably involve
some sacrifice in margins in the near term, impacting stock performance for now
but should hold Infosys in good stead in the medium term. Valuation multiples c.f.
peers can sustain and also throws up potential for re-rating in the future.
Given this catch-22 situation, we believe TCS is a better stock to own over the next
12 months. TCS has taken some of the margin hit during the 2008-09 time frame
when it showed greater flexibility to clients on deals, the key instance being buyout
of the Citi BPO. Some of those investments have paid up and aided TCS’ growth
over the last 12-18 months. In our view, Infosys needs to play catch-up here.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Growth or margin leadership?
Revenue growth remains the key to higher stock returns.
Offshore IT vendors have used different business strategies over the past decade.
While Infosys has tried to maintain its premium margins, Cognizant has sought to
remain a growth leader operating at much lower margins. More recently, TCS has
managed bit of both while HCL is trying to replicate Cognizant. Our analysis of stock
performance over the past few years indicates that revenue growth leadership has
consistently triumphed margin leadership in delivering stock returns. The street is
more palatable to lower margins as long as revenue growth remains strong. Volume
growth with stable margin remains the elixir of stock returns in IT Services.
This note analyses Cognizant (proxy for growth leadership) and Infosys’ (proxy for
margin leadership) financials over the past few years and concludes that the drive
for higher revenue growth has helped Cognizant close the gap with Infosys not only
on revenues but also on operating profits. Moreover, Infosys’ inability to re-deploy
its capital more profitably has resulted in significantly higher compression of ROEs
c.f. Cognizant. Expectedly, the street has rewarded Cognizant’s growth leadership
with a much higher return (cum dividends) across every time period in last 7 years.
Thus, historical experience suggests that if Infosys remains focused on maintaining
its margin levels, its stock runs the risk of not only further underperforming
Cognizant but also peers like TCS and HCL who have upped the ante on revenue
growth. At the same time, if Infosys chooses to drop margins to drive above peer
revenue growth, near-term earnings hit could impact stock performance. TCS is our
top pick in the sector over the next 12 months.
Cognizant’s revenue leadership driving better stock returns
Infosys’ margin leadership not helping as much
Cognizant’s focus on market share gain while maintaining a stable lower margin
level has resulted in rapid closing of the revenue gap with Infosys. 6 years back,
Infosys’ revenues were 2.5x Cognizant’s but in the latest quarter, Infosys is ahead
only by ~20% (See Figure 1). Note that neither company has been excessively
acquisitive in this period. In fact, the absolute revenue differential (See Figure 2)
between the two companies in Dec-10 quarter is similar to the Sep-05 quarter
despite the fact that Infosys’ revenues have grown three-fold over this period.
Revenue league tables remain important in IT Services as scale is an important
determinant of invite for new deals. Also, it aids employee hiring and retention.
Faster revenue growth has also helped Cognizant close the gap on operating profit.
Cognizant’s operating profit is now half of Infosys’, up significantly from a quarter,
6 years ago (See Figure 3). In fact, over the last 2 years, Cognizant has added as
much operating profit as Infosys. Note that Cognizant’s lower margins c.f. Infosys
are not just because of Infosys’ higher cost efficiencies. It is as much driven by
Cognizant’s willingness to be flexible to client demands (which drives better
growth), its higher bonus provisioning (which helps retain employees) as by
Infosys’ overall better cost management.
Catch-22 situation for Infosys?
Infosys has two investment futures, both of which rest on a strong 2011, where
sceptical debate is waning, unless cataclysmic macroeconomic events intervene.
However, one of the possible pathways suggests that while 2011 will be a good
year for Infosys on revenue growth, peers could outperform once again on
revenues if Infosys continues to focus on margins. Exit rate for TCS, HCL and
Cognizant is already much more favourable than Infosys. This could potentially hurt
relative multiples further impacting stock performance c.f. peers. Note that barring
Wipro other Tier-1 IT peers have all re-rated c.f. Infosys through the last 18-24
months and some of it is attributable to the slower revenue growth.
The second scenario is a brighter one from a medium to long term perspective but
unfavourable over the next 12-18 months. Infosys reinvents itself, introduces new
services, gets more flexible on deals, breaks the linear equation of revenueemployees
and opens new markets through greater investment in sales &
marketing. This should help drive faster revenue growth. This will invariably involve
some sacrifice in margins in the near term, impacting stock performance for now
but should hold Infosys in good stead in the medium term. Valuation multiples c.f.
peers can sustain and also throws up potential for re-rating in the future.
Given this catch-22 situation, we believe TCS is a better stock to own over the next
12 months. TCS has taken some of the margin hit during the 2008-09 time frame
when it showed greater flexibility to clients on deals, the key instance being buyout
of the Citi BPO. Some of those investments have paid up and aided TCS’ growth
over the last 12-18 months. In our view, Infosys needs to play catch-up here.
No comments:
Post a Comment