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INFOSYS TECHNOLOGIES LTD
RECOMMENDATION: BUY
TARGET PRICE: RS.3273 FY12E P/E: 20.7X
Infosys' 1QFY12 results were marginally above our estimates. Volume
growth at 4% was encouraging in an uncertain macro environment. Billing
rates were lower on off-shore side but largely remained stable and margins
came largely in line with estimates. Higher-than-expected tax impacted PAT
growth, which came in below consensus estimates. FY12 guidance was
below expectations.
We note that, the company has outperformed its guidance on revenue and
margin fronts despite no major change in the macro scene QoQ. The margin
performance is better despite a rise in proportion of on-site revenues.
Moreover, the management has indicated higher project starts (increase in
on-site proportion indicates that) and continuing large / transformational
deal wins. The company has won 5 - 6 deals in the products / platforms
business.
We opine that, management has taken a conservative view of the macro
uncertainties, while giving guidance, which fell short of expectations. There
have been no project cancellations till date and clients continue to be
optimistic. Spending pattern has been volatile, though. Revenues are
expected to rise by 18% - 20% YoY in USD terms. Margins in FY12 are
expected to fall by about 250bps YoY as against earlier guidance of a 300bps
fall. Infosys will be adding 45000 people on a gross basis for FY12. This
reflects management's confidence in FY12 growth rates.
We make changes to our FY12E earnings estimates. Our FY12E EPS stands at
Rs.135 (INR - USD exchange rate at 44.5) v/s Rs.138 earlier. The fall is due to
marginally lower volume growth assumptions and higher tax. Stronger
demand may flow straight to the bottom-line as assumed utilization levels
at less than 78% leave scope for improvement. Our price target is
consequently revised to Rs.3273 v/s Rs.3340 earlier. At our TP, our FY12E
earnings will be discounted about 24x, which is at the mid-point of the
valuation range during the previous upturn.
Infosys should benefit over the medium term, from the positive change in
client sentiments and the presence of various margin levers, we opine.
Infosys' long term strategy is geared towards providing services through
new engagement models. We remain optimistic on the company's future
prospects, led by a strong management team and maintain BUY.
INR revenues grew by 3%, volumes by 4%
n Infosys reported a 4% QoQ rise in volumes. This was encouraging in the backdrop
of an uncertain macro scene, as indicated by the management.
n In fact, the on-site volumes grew by 6.8% QoQ and off-shore volumes 2.7%.
The sharp rise in on-site volumes likely indicates new project starts because new
projects have a higher proportion of on-site services.
n We note that, the previous quarter had seen volumes de-grow by 1% QoQ.
n The company continued to win large deals. In 1QFY12, Infosys won 3 large deals
and 3 transformational deals, indicating continued interest in outsourcing and
offshoring. The management indicated that, deals of $500mn are also floating in
the market. .
n Revenues from North America grew by 5% in CC terms in turn supporting the
overall growth.
n Revenues from Europe grew at a more subdued pace as the macro uncertainties
impacted the pace of decision making. However, here also, the management
has not witnessed any project cancellations.
n Within verticals, BFSI witnessed subdued growth as some of the discretionary
spends faced challenges. Overall discretionary spends are flat across sectors, we
understand.
n Within the vertical, areas like Capital Markets witnessed a 5.5% QoQ growth.
The sector also saw increased traction in consulting as well as in non-linear revenues
(products and Platforms).
n As far as BFSI is concerned, demand is originating from areas like fraud prevention,
risk management and compliance, even as tailwinds continue in M&A related
projects. The company has also signed contracts in areas like anti money
laundering.
n This is the second successive quarter of subdued growth in BFSI for Infosys.
n In manufacturing, clients are focusing more on improving efficiencies, opening
doors for transformational projects and consulting / package implementation services.
n Retail/CPG/Life-sciences, the newly structured group, saw a 9% rise QoQ. The
relatively young vertical has witnessed consistent growth over the past few quarters
and we see this as a driver for growth in the future.
n In Energy/Utilities/Communication and Services, the other newly structured
group, clients are looking at becoming e-ready and new opportunities are coming
up in these areas.
n However, this group reported a de-growth, largely due to consistent lower spending
by large telecom clients.
n According to the management, the scale down in the telecom clients is flattening
out and 2Q could see the bottom. The vertical is expected to witness revival
in spending because of new legislative changes proposed in USA. According to
the management, the pipeline in this vertical is strong.
n In terms of services, the Business Innovation services (Products, Platforms, Solutions)
reported a 4.5% QoQ growth in INR terms.
n The company won 5 orders for the iENGAGE platform and one order for the
iTRANSFORM platform.
n We view this as a positive development. Infosys has been focusing on non-linear
revnues with a view to provide better value to customers and also protect margins.
n Infosys is targeting almost a third of its revenues to come from these services
over the next few years as compared to about 8% currently.
n We view the 4% volume growth as encouraging in the backdrop of an uncertain
macro environment.
Macro scene uncertain; no impact on client budgets, though
n Infosys' management maintained that, the macro scene remains uncertain because
of the issues in USA as well as Europe. The economic data in USA has not
been positive and the debt crises have impacted sentiments in Europe.
n However, this has not yet translated into any budget cuts or deferrals by clients.
Clients are positive about their own prospects and continue to maintain their target
budgets.
n While the budgets are not being cancelled, volatility in spends continue, based
on the significant new developments in the global economy. FY12, though, is
expected to be a normal year for demand.
n A shift in client focus from cost control to efficiency increases augers well for the
transformational and consulting services of Infosys, we opine.
n According to the management, discretionary spends are almost flat and are not
witnessing much traction.
n We understand the management has likely taken a conservative view of the
short term challenges. While there is uncertainty in the global scene, we do not
expect and major economy downfalls.
Average realizations - fall in off-shore realisations
n According to the management, billing rates were largely stable. Average realizations
were almost flat on a CC basis and about 1.2% higher in reported terms.
We understand this was largely due to the higher on-site proportion.
n Off-shore realizations were lower QoQ by about 1%. We understand from the
management that, this was one-off and not a trend. However, we need to
watch this number closely in 2QFY12.
n We are of the opinion that, increased proportion of non-linear revenues in future
quarters will likely support average realizations.
n Infosys has increased the share of revenues from new engagement models to
about 8%.
Margins down
n Infosys reported a 290bps fall in EBIT margins, which was largely in line with
expectations, but better than what the company had guided for.
n Margins fell due to salary increments and rupee appreciation v/s USD. Infosys
gave a 10-12% off-shore salary hike and about 2% on-site hike.
n Margins were also likely impacted by the higher proportion of on-site revenues -
50.5% v/s 49.3% QoQ.
n We note that, the company was able to restrict the impact on margins despite
higher on-site revenues. Cost rationalization and efficiency gains helped in restricting
the impact on margins.
Employee additions and promotions
n Infosys added 2740 employees on a net basis. Attrition moderated to 15.3% on
an LTM basis.
n Infosys has maintained its target of adding 45000 employees on a gross basis in
FY12.
Forex gains and tax
n Infosys had a forex gain of about Rs.450mn (Rs.410mn QoQ) during the quarter.
n The company had hedges of about $745mn v/s $620mn as at 4QFY11 end.
n Company provided for tax at a higher rate of 28% during the quarter and expects
the tax rate to be at about 28% in FY12.
FY12 guidance - weighed down by macro concerns, we believe
n Infosys has maintained its 18% - 20% growth guidance for FY12 in USD terms.
Margins are expected to fall by 250bps v/s 300 bps guided earlier. FY12 EPS is
expected to be between Rs.128 - Rs.130.
n The revenue guidance has been maintained despite a marginal beat in 1Q,
largely because of macro concerns, which has led to delays in decision-making.
n We understand that, the management has taken a conservative view which giving
guidance. Client budgets are stable, according to the management. We note
that, 1Q revenues beat the guidance despite no positive change in macro scene
during the quarter. Project starts have likely been higher during the quarter, we
understand. Moreover, the large and transformational deals continue to flow.
n We have assumed volume growth of 21% in FY12.
n In line with the revenue growth, we expect margins to moderate by about
180bps v/s guidance of a 250bps fall.
n If the revenue growth is higher, the same may largely flow to the bottom-line as
the utilization levels are assumed at less than 78%.
We tweak our earnings estimates
n We have made necessary changes to our earnings estimates for FY12. This is
largely due to changes in volume growth. We have also assumed higher tax rate
at 28%.
n We expect volumes to grow by 21% YoY. Average realizations are expected to
be at 1QFY12 levels. We have assumed the rupee at Rs.44.50 per USD by FY12
end.
n EBIT margins are expected to be lower in FY12 due to the expected rupee appreciation,
lower utilization levels and salary hikes.
n The revenue growth (pyramid effect) and other cost initiatives are expected to
restrict the impact.
n After considering 28% tax rate, PAT is expected to rise to about Rs.77.1bn in
FY12, an EPS of Rs.135 (Rs.138 earlier).
Valuations
n We have valued the stock based on FY12 estimates. At our TP of Rs.3273
(Rs.3341), Infosys will quote at about 24x FY12 estimated earnings, which is at
the mid-point of the valuation range enjoyed by Infosys in the previous upturn.
Concerns and risks
n A sharp appreciation in the rupee against various currencies will impact our earnings
estimates.
n Delay in the economic recovery of major user economies will likely impact future
revenue growth of the company.
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