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Infosys Ltd (INFY.BO)
Hold: 1QFY12 Results Disappoint
Revenues (+4.3% qoq) below expectations; pricing down — Q1 revenues at
$1.67b (+4.3% qoq) were slightly lower than our 5% growth expectation. Volumes
increased ~4% qoq while offshore/onsite pricing was down qoq – against street
expectations of an uptick. Constant currency revenue growth was 3.1% qoq.
No change in guidance a bigger surprise — Despite Q1 revenues above guidance,
management did not raise their FY12 revenue guidance from 18-20% growth.
Management cited challenging global macro as the reason for the same. Q2 guidance
of 3.5-5.0% growth is subdued – surprising in the context of good onsite growth in Q1.
Margins disappoint — EBIT margins declined ~290bps qoq – higher than what the
street was expecting – primarily on account of wage hikes (10-12% offshore/2-3%
onsite), currency and investments. FY12 margin guidance was raised up – now implies
decline of ~250bps yoy (earlier ~300bps yoy) – street already at ~100-110bps yoy.
Management cautious — Management suggested that discretionary spend was
flattish (positive earlier), pricing was stable (against expectations of some uptick), Infy
will need higher investments in Europe to make it grow (investors were hoping Europe
recovers) and telecom continues to struggle. Deal wins (3 large/3 transformational)
were good; no increase in FY12 guidance does suggest cautious stance.
What does the guidance now imply? — If Infosys delivers ~6% qoq in Q2, the FY12
guidance (higher end) now implies ~5% growth in Q3/4 – which may be difficult to beat
meaningfully given the seasonality associated.
“Hopes” move to Q2; difficult to see the stock outperform — We believe there are
downside risks to consensus FY12 estimates – stock price decline of ~20% YTD partly
factors the same. Investors will now be hoping for a strong Q2 – stock could languish in
the near term
Key Highlights
Revenues were $1,671m, up 4.3% qoq (CIRA expectations: $1,682m).
EBITDA margin of 29.1% (CIRA expectations: 29.6%), down ~290bps
sequentially. This was primarily on account of salary hikes.
Net profit of Rs17.2b vs. our expectations of Rs17.1b – inline despite lower
topline and margins due to higher than expected other income.
Constant currency realizations were flat on a blended basis despite the onsite
shift of revenues by 140bps qoq. Offshore rates declined ~1.5% (estimated) on a
constant currency basis.
IT volumes were up 4.0% sequentially on a blended basis – offshore volumes
increased 2.7% qoq while onsite volumes increased 6.8% qoq.
2Q revenue growth guidance is 3.5-5% qoq. EPS guidance is flat qoq – given
appreciated INR and lower other income. Management expects 2Q margins to be
flat qoq.
Headcount increased by 2,740 employees on a net basis. Hiring guidance for
FY12 is ~45,000 gross employees (unchanged).
Growth was led by Retail and Insurance where revenues increased by 15.8%
and 5.8% qoq respectively. Telecom was down 7.1% qoq while Banking &
Financial Services was up 2.8% qoq.
In terms of Service lines, growth was led by Application Maintenance at 5.7% qoq
while System Integration and Testing grew 7.7% and 7.2% respectively. Among
the larger Service lines, Consulting & PI lagged company average with a growth
rate of 3.5% qoq.
North America grew 5.1% qoq while Europe was flattish at 0.5% (decline in
constant currency though).
BPO subsidiary had revenue growth of ~2% qoq; net margins declined to ~10%
(~17% in 4Q).
Top-10 clients grew 5.6% qoq while clients outside this bucket grew 3.9%.
Attrition decreased by ~120bps on a LTM basis.
What does it imply for the sector?
Offshore pricing decline does suggest that street’s optimism on pricing may be
misplaced. Of late, pricing commentary from most large companies has
moderated.
Europe continues to be a worry – likely to continue impacting growth rates given
that worries continue.
Telecom continues to be a challenge for most players.
Management indicated that discretionary spend was flattish – against most
expectations of a rebound. While it is difficult to take a view based on one data
point, investors will look forward to other earnings for clarity on the same.
Expectations for the sector (particularly TCS/Infosys and now HCLT) continue to
run high, in our view. This, given the underlying challenges, continues to worry us
– in the sector context.
Infosys Ltd
Company description
Infosys is the second-largest Indian IT services company with more than 130,000
professionals, and is a leader in the offshore services space. Infosys provides
business consulting, application development & maintenance and engineering
services to 620 clients across verticals such as Banking, Financial Services,
Insurance, Retail, Manufacturing and Utilities in the Americas, Europe and Asia
Pacific. Infosys also sells a core banking application, Finacle, which is used by
leading banks in India, the Middle East, Africa and Europe. Its subsidiary, Infosys
BPO, which employs more than 18,000 people, is a provider of BPO services.
Investment strategy
We rate Infosys shares as Hold/Low Risk (2L). We are positive on the company's
fundamentals. Offshore IT outsourcing has become a mainstream option, and we
think that scale and scalability, along with an ability to move up the value chain, are
key criteria for successful offshore vendors. In this respect, Infosys appears well
positioned and continues to gain ground given its strong branding and industryleading sales force. We expect Infosys to deliver a revenue CAGR of ~22% ($
terms) and an earnings CAGR of ~18% for FY11-13E. Unlike other high-growth
firms in other industries, Infosys continues to generate solid FCF and its RoE of
~25-30% remains well above its cost of capital.
Valuation
Our Rs3,230 target price for Infosys is based on 21x Sep'12E EPS. This is close to
the higher end of the last 3-year trading band of 10-24x 12-month forward earnings
and factors in marginal deceleration in growth. Our estimates continue to assume a
certain PE premium to the market; this is justified, in our view, given the strong FCF
and ROIC for Infosys vs. the overall market. We believe PE remains the most
appropriate valuation measure given Infosys' profitability record and higher earnings
visibility.
Risks
We rate Infosys Low Risk which is in line with our quantitative risk-rating system,
which tracks 260-day historical share price volatility. Key downside risks to our
target price include: (1) any significant appreciation of the rupee against the
USD/EUR/GBP; (2) pressure on billing rates; and (3) a prolonged slowdown in the
US economy. Key upside risks that could cause shares to exceed our target price
include: (1) a sharp recovery in the US/Global economy; and (2) any significant
depreciation of the rupee against the USD/EUR/GBP.
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