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We initiate coverage of Infosys with a 1-Overweight rating and 12-month price target of
INR3,050, based on a target P/E multiple of 17.5x. A significant decline in revenue from
one of its major clients, British Telecom, could be the key factor behind the weak
revenue performance of Infosys in the past six quarters. This revenue decline could end
soon as British Telecom now has a lower contribution to revenue mix thereby leading to
a positive surprise on growth. Furthermore, we find Infosys’s margin guidance for the
year ending March 2012 conservative and we expect actual numbers to come in ahead
of guidance. Finally, low hedging could help Infosys amid the current rupee
depreciation.
Investment summary
Best revenue growth amongst peers: Infosys has exhibited the best organic revenue
growth among the large-cap Indian IT companies in the past decade. This is largely a result
of strong execution by the company rather than lucky strategic breaks. For example, Infosys
was one of the last major Indian IT vendors to invest in BPO, but it has managed to build
one of the best BPO practices, in our opinion.
Strong margin focus: The capability of Infosys management is reflected in its ability to not
only deliver the best revenue growth but also to deliver it along with the strongest margins
and limited use of balance sheet. We believe this reflects company’s strong internal
processes and systems, along with a top-tier sales team.
Near-term cautious commentary reflects conservative stance: Infosys’s management
team has been cautious in the past few quarters on the back of its worries about the macro
environment. We note that Infosys is the only large Indian IT company to give guidance and,
hence, it is usually more transparent about its market views. Management has also been
clear that it has seen limited (if any) impact on the business but worries that macro
weakness could impact revenue.
Valuations look inexpensive: Infosys is trading at a mid-point of it P/E multiples for the
past five years – a period that includes the financial crisis period of 2008-09. It is also
trading at its lowest premium to the Indian market and is actually at a 9.8% discount to
TCS. We base our target price on a P/E of 17.5x, which we view as fair despite market
uncertainty.
Valuation
Our 12-month target price of INR3,050 for Infosys is based on a P/E of 17.5x, which we
apply to the average of our EPS estimates for FY2013 and FY2014, which is INR171. Our
target multiple for Infosys is in line with Infosys’s past five-year average.
For the Indian IT vendors, we believe P/E is the most appropriate valuation method because
earnings best incorporate the two main drivers of the business: revenue growth that is a
result of new contract signings and margin resilience that comes from operational
efficiencies and the position in the IT services value chain.
We rate Infosys as 1-Overweight because our price target represents 24% potential upside –
at the high end of its peers – amid our expectations of positive surprises for revenue growth.
Risks
The risks that could keep our price target from being achieved, in our view, include the
following: 1) a weaker global macroeconomic scenario could slow down the process of
incremental business from new and existing customers; 2) management changes over the
past couple of years have caused some overhang, with any further shuffle in top
management being a risk; and 3) demand unevenness has caused some issues in
management of staffing levels that has had a margin impact and should be monitored.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
We initiate coverage of Infosys with a 1-Overweight rating and 12-month price target of
INR3,050, based on a target P/E multiple of 17.5x. A significant decline in revenue from
one of its major clients, British Telecom, could be the key factor behind the weak
revenue performance of Infosys in the past six quarters. This revenue decline could end
soon as British Telecom now has a lower contribution to revenue mix thereby leading to
a positive surprise on growth. Furthermore, we find Infosys’s margin guidance for the
year ending March 2012 conservative and we expect actual numbers to come in ahead
of guidance. Finally, low hedging could help Infosys amid the current rupee
depreciation.
Investment summary
Best revenue growth amongst peers: Infosys has exhibited the best organic revenue
growth among the large-cap Indian IT companies in the past decade. This is largely a result
of strong execution by the company rather than lucky strategic breaks. For example, Infosys
was one of the last major Indian IT vendors to invest in BPO, but it has managed to build
one of the best BPO practices, in our opinion.
Strong margin focus: The capability of Infosys management is reflected in its ability to not
only deliver the best revenue growth but also to deliver it along with the strongest margins
and limited use of balance sheet. We believe this reflects company’s strong internal
processes and systems, along with a top-tier sales team.
Near-term cautious commentary reflects conservative stance: Infosys’s management
team has been cautious in the past few quarters on the back of its worries about the macro
environment. We note that Infosys is the only large Indian IT company to give guidance and,
hence, it is usually more transparent about its market views. Management has also been
clear that it has seen limited (if any) impact on the business but worries that macro
weakness could impact revenue.
Valuations look inexpensive: Infosys is trading at a mid-point of it P/E multiples for the
past five years – a period that includes the financial crisis period of 2008-09. It is also
trading at its lowest premium to the Indian market and is actually at a 9.8% discount to
TCS. We base our target price on a P/E of 17.5x, which we view as fair despite market
uncertainty.
Valuation
Our 12-month target price of INR3,050 for Infosys is based on a P/E of 17.5x, which we
apply to the average of our EPS estimates for FY2013 and FY2014, which is INR171. Our
target multiple for Infosys is in line with Infosys’s past five-year average.
For the Indian IT vendors, we believe P/E is the most appropriate valuation method because
earnings best incorporate the two main drivers of the business: revenue growth that is a
result of new contract signings and margin resilience that comes from operational
efficiencies and the position in the IT services value chain.
We rate Infosys as 1-Overweight because our price target represents 24% potential upside –
at the high end of its peers – amid our expectations of positive surprises for revenue growth.
Risks
The risks that could keep our price target from being achieved, in our view, include the
following: 1) a weaker global macroeconomic scenario could slow down the process of
incremental business from new and existing customers; 2) management changes over the
past couple of years have caused some overhang, with any further shuffle in top
management being a risk; and 3) demand unevenness has caused some issues in
management of staffing levels that has had a margin impact and should be monitored.
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