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Infosys Technologies Neutral
INFY.BO, INFO IN
Non-operating factors crucially influence Infosys' EPS
growth in FY12E; accordingly, adjust the P/E multiple
• Much analysis has already been done on Infosys’ guidance for FY12 (we
predict 18-20% USD revenue growth in constant currency terms) and what it
means for the sector. Consensus expects Infosys’ earnings growth rate in FY12
to trump that of TCS; we, too, expect modest earnings outperformance for
Infosys (vis-à-vis TCS). If investors appreciate the source/cause of Infosys’
higher earnings growth, it should be a minor consideration at best in setting P/E
multiples for Infosys. In analyzing Infosys’ expected EPS growth in FY12, we
cite two factors that contribute significantly to Infosys’ earnings growth.
• The two factors include: (a) lower/no step-up in tax rates; and (b) all-time high
interest income as a percentage of PBT helped by rising deposit yields. These
factors may be deemed non-operating and less relevant to setting the P/E
multiple.
• Lower step-up in tax rates for Infosys helps it register higher earnings
(EPS) CAGR over FY11-13. We think Infosys’ effective tax rates (ETR) at
26-27% will stay in a narrow band while for TCS the jump in FY12 (of ETR)
will likely be meaningfully higher by 400 bps from 19% to 23% (as also for
Wipro). However, logically their P/Es should not be impacted. P/Es are
impacted if there is a change in expectations of business-related earnings
growth profile over time. Therefore, any dislocation in multiples for TCS &
Wipro versus Infosys due to one-offs such as tax rate step-ups is likely to be
temporary.
• The contribution of other income to Infosys’ FY12 is likely to be all-time
high as % of PBT (at 14%). We estimate Infosys' core business EPS at Rs133
(versus Rs108 in FY11, i.e. ~23% growth Y/Y). Post-tax interest income is
likely to grow from Rs12 in FY11E to Rs19-20 FY12E (over a 50% increase
Y/Y because of rising yield). So, while our estimate of growth for the core
business is 23%, the post-tax interest income grows more than 50% to give an
overall EPS growth of 27% (in FY12E). Should investors pay the same
multiple on the post-tax interest income as they would on the core business?
We think not.
• Conclusion. If the source of Infosys’ EPS growth outperformance were due to
factors unrelated to the core business and accrues from below the operating line
(below EBIT) items, we believe that investors should also be cognizant of this in
setting the FY12 P/E multiple for Infosys. There is a tendency to peg P/E
multiples based on earnings CAGR but if the earnings CAGR is helped by noncore
factors, the attribution of the multiple may be misplaced. PEG-based
valuation approaches could mislead. We retain our Neutral rating on
Infosys. We continue to prefer TCS (OW) and Wipro (OW).
Understanding what leads to the earnings growth before
attributing a multiple to that growth
In our view, multiples should track sustainable growth of the core-business. Factors
that can influence earnings growth include non-core aspects such as interest income
and tax rates. As discussed, we think Infosys gains from both these factors in FY12.
We believe that investors must adjust for this in setting their multiple for Infosys’
stock. We forecast Infosys’ pre-tax core EBIT will rise 24% in FY12 (versus FY11)
during which period TCS’ EBIT rises 28%. We think the EBIT profile over FY11-13
is likely to most determine multiples, not the EPS growth if below-the-operating line
items crucially influence EPS growth (as they do for Infosys in FY12).
We thus expect TCS to continue to outperform operationally. Multiples should
track this growth, rather than EPS growth. Given this logic, TCS’ P/E multiple
should sustain its premium over that of Infosys (which we believe should be 5-
10%).
Cash yield has increased meaningfully in the last few months and the importance of
interest income has further increased for Infosys. Adjusting for the higher cash yield,
we have increased our FY12 EPS estimate by about 2% to Rs152.
Tweaking FY12 EPS upwards for higher interest income
Our FY12 EPS estimate increases by about 2% due to increased interest income
driven by higher deposit yield. Revenue estimates are unchanged in US$ terms, but
moved up slightly due to changed exchange rate assumptions. Thus, our
operational estimates remain largely unchanged.
Conclusion
If the source of Infosys’ EPS growth outperformance in FY12 is due to factors
unrelated to the core business and accrues from below-the-operating line (below
EBIT), we believe that investors should also be cognizant of this in setting the FY12
P/E multiple for Infosys. PEG-based valuation approaches could thus mislead.
We retain our Neutral rating on Infosys. The stock trades at 21.2x FY12E
earnings (P/E). We continue to prefer TCS (OW) and Wipro (OW).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Infosys Technologies Neutral
INFY.BO, INFO IN
Non-operating factors crucially influence Infosys' EPS
growth in FY12E; accordingly, adjust the P/E multiple
• Much analysis has already been done on Infosys’ guidance for FY12 (we
predict 18-20% USD revenue growth in constant currency terms) and what it
means for the sector. Consensus expects Infosys’ earnings growth rate in FY12
to trump that of TCS; we, too, expect modest earnings outperformance for
Infosys (vis-à-vis TCS). If investors appreciate the source/cause of Infosys’
higher earnings growth, it should be a minor consideration at best in setting P/E
multiples for Infosys. In analyzing Infosys’ expected EPS growth in FY12, we
cite two factors that contribute significantly to Infosys’ earnings growth.
• The two factors include: (a) lower/no step-up in tax rates; and (b) all-time high
interest income as a percentage of PBT helped by rising deposit yields. These
factors may be deemed non-operating and less relevant to setting the P/E
multiple.
• Lower step-up in tax rates for Infosys helps it register higher earnings
(EPS) CAGR over FY11-13. We think Infosys’ effective tax rates (ETR) at
26-27% will stay in a narrow band while for TCS the jump in FY12 (of ETR)
will likely be meaningfully higher by 400 bps from 19% to 23% (as also for
Wipro). However, logically their P/Es should not be impacted. P/Es are
impacted if there is a change in expectations of business-related earnings
growth profile over time. Therefore, any dislocation in multiples for TCS &
Wipro versus Infosys due to one-offs such as tax rate step-ups is likely to be
temporary.
• The contribution of other income to Infosys’ FY12 is likely to be all-time
high as % of PBT (at 14%). We estimate Infosys' core business EPS at Rs133
(versus Rs108 in FY11, i.e. ~23% growth Y/Y). Post-tax interest income is
likely to grow from Rs12 in FY11E to Rs19-20 FY12E (over a 50% increase
Y/Y because of rising yield). So, while our estimate of growth for the core
business is 23%, the post-tax interest income grows more than 50% to give an
overall EPS growth of 27% (in FY12E). Should investors pay the same
multiple on the post-tax interest income as they would on the core business?
We think not.
• Conclusion. If the source of Infosys’ EPS growth outperformance were due to
factors unrelated to the core business and accrues from below the operating line
(below EBIT) items, we believe that investors should also be cognizant of this in
setting the FY12 P/E multiple for Infosys. There is a tendency to peg P/E
multiples based on earnings CAGR but if the earnings CAGR is helped by noncore
factors, the attribution of the multiple may be misplaced. PEG-based
valuation approaches could mislead. We retain our Neutral rating on
Infosys. We continue to prefer TCS (OW) and Wipro (OW).
Understanding what leads to the earnings growth before
attributing a multiple to that growth
In our view, multiples should track sustainable growth of the core-business. Factors
that can influence earnings growth include non-core aspects such as interest income
and tax rates. As discussed, we think Infosys gains from both these factors in FY12.
We believe that investors must adjust for this in setting their multiple for Infosys’
stock. We forecast Infosys’ pre-tax core EBIT will rise 24% in FY12 (versus FY11)
during which period TCS’ EBIT rises 28%. We think the EBIT profile over FY11-13
is likely to most determine multiples, not the EPS growth if below-the-operating line
items crucially influence EPS growth (as they do for Infosys in FY12).
We thus expect TCS to continue to outperform operationally. Multiples should
track this growth, rather than EPS growth. Given this logic, TCS’ P/E multiple
should sustain its premium over that of Infosys (which we believe should be 5-
10%).
Cash yield has increased meaningfully in the last few months and the importance of
interest income has further increased for Infosys. Adjusting for the higher cash yield,
we have increased our FY12 EPS estimate by about 2% to Rs152.
Tweaking FY12 EPS upwards for higher interest income
Our FY12 EPS estimate increases by about 2% due to increased interest income
driven by higher deposit yield. Revenue estimates are unchanged in US$ terms, but
moved up slightly due to changed exchange rate assumptions. Thus, our
operational estimates remain largely unchanged.
Conclusion
If the source of Infosys’ EPS growth outperformance in FY12 is due to factors
unrelated to the core business and accrues from below-the-operating line (below
EBIT), we believe that investors should also be cognizant of this in setting the FY12
P/E multiple for Infosys. PEG-based valuation approaches could thus mislead.
We retain our Neutral rating on Infosys. The stock trades at 21.2x FY12E
earnings (P/E). We continue to prefer TCS (OW) and Wipro (OW).
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