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http://www.kotaksecurities.com/pdf/indiadaily/indiadaily16042012.pdf
Infosys: Disappointing; no apparent positives
` 4QFY12 - weak on all counts
` 'No guidance' may have been better than FY2013E guidance
` Infosys performance - a mix of company specific and broader industry
challenges
` Prepare for more volatility, ADD rating retained only on inexpensive
valuations
Disappointing; no apparent positives. Infosys results and guidance disappointed on
all counts. Apparent lack of control has undermined the relevance of the guidance;
FY2013E guidance is incoherent and faces the same issues as FY2012. We may have
underestimated execution issues of Infosys but do highlight that spending cuts in two
large verticals, visa issues and competition are playing a part in impacting equilibrium of
the industry. We cut FY2013E revenue growth to 7.5%, EPS to Rs162 and target price
to Rs2,750. Inexpensive valuation prevents a rating downgrade. ADD stays.
4QFY12—weak on all counts
Infosys missed its revenue guidance for the 5
th
consecutive quarter. Revenues declined 2% qoq or
US$35 mn of which BFSI accounted for US$28 mn. Volumes declined 1.5% qoq while pricing was
down 1.3%. Surprisingly Infosys recruited ~5,000 people and now runs business at utilization
(including trainees) of 64%, lowest in many years. This reflects a big gap in business planning or poor
control of operations. Net income of Rs23.2 bn beat estimate but was boosted by high other income.
‘No guidance’ may have been better than FY2013E guidance
Infosys has missed guidance for the past 5 quarters on constant currency. Consistent miss reflects
a weak process for setting the guidance. Unfortunately FY2013E revenue growth guidance
indicates that nothing much has changed on process. Management commentary fails to inspire
any confidence. A high ask rate of 4.3-4.8% from 2Q-4Q to achieve full-year estimate after weak
1Q guidance fails to inspire any confidence. We forecast 7.5% revenue growth for FY2013E.
Infosys performance—a mix of company specific and broader industry challenges
While we do not doubt the opportunity size for the industry, increased competition along with
slowdown in two large verticals for offshore IT (telecom service providers and financial services)
has impacted industry equilibrium. This will translate into more intense competition, disruptive
pricing strategies and shift of business depending on value proposition demonstrated by different
vendors. We discuss some of these aspects in detail on the subsequent pages.
Prepare for more volatility, ADD rating retained only on inexpensive valuations
We cut our FY2013E revenue growth estimate to 7.5% from 12% earlier. Cut in revenue growth
captures loss of share of business to peers—Infosys’ inability to demonstrate value proposition to
clients or inflexibility on pricing may be hurting more than our estimate; slowdown in key verticals
does not help either. We cut our FY2013E EPS estimate by 5% to Rs161.5. We cut target price to
Rs2,750 from Rs3,100 earlier, valuing the company at 17X FY2013E earnings. Inexpensive
valuation (15X FY2013E EPS) prevents a downgrade. ADD
Earnings snapshot
` Revenues of US$1,771 mn, -1.9% qoq, +10.5% yoy (guidance: US$1,806 – 1,810 mn;
KIE estimate: US$1,817 mn)
` EBITDA of Rs28.92 bn, -7.8% qoq, +24.4% yoy (KIE: Rs28.85 bn)
` EBITDA margin of 32.7%, down 100 bps qoq and up 60 bps yoy (KIE: 31.9%)
` Net income of Rs23.16 bn, down 2.4% qoq, +27.4% yoy (KIE: Rs22.58 bn)
` EPS of Rs40.54/share
Guidance – FY2013E and 1QFY13E
` FY2013E revenue growth – 8-10% US$ terms (KIE estimate was 9-12%), 13.9-16.0% Re
terms
` FY2013E EPS – Rs158.76-161.41/share, up 9.1-10.9% yoy (KIE estimate was Rs159-
166/share)
` 1QFY13E revenue growth – 0-1% qoq (KIE estimate was 2-3%)
` FY2013E revenue guidance implies a CQGR of 4.3-4.8% over 2Q-4QFY13E
` Guidance assumes EBIT margin decline of 70 bps yoy (versus 29% in FY2012) and a
Re/US$ rate of 50.88 (versus 48.23 realized in FY2012)
Key operating metrics and other highlights
` Constant currency revenue decline of 2.1% qoq; cross-currency uplift of 20 bps
` Volume growth – down 1.5% qoq
` Constant currency pricing – down 0.4% onsite, down 1.8% offshore, down 1.3%
blended
` End-period headcount of 149,994, a net addition of 4,906 qoq; quarterly annualized
attrition at 15.6%, down from 17.8% in the previous quarter
` Utilization (ex-trainees) down 570 bps qoq to 70.7%; utilization (including trainees) down
340 bps qoq to 64.2%
` Vertical mix – disappointing across the board, BFSI in particular
` Geographical mix – 4% qoq decline in North America. Europe was flat
` Client metrics – weak across the board
` End-period cash balance – a little over US$4 bn
` Final dividend of Rs22/share and a special dividend of Rs10/share, taking the total
dividend for FY2012 to Rs47/share. Ex-special dividend payout of Rs37/share for the year
implies a dividend payout ratio of 25%
` The total outstanding hedges as of Dec 31, 2011 was US$889 mn (up from US$847 mn
at the end of the previous quarter)
Decision against wage increase may backfire; better option was to backtrack on
hiring commitments
Infosys has decided against a wage increase for FY2013 per the normal April cycle. The
company has indicated that it would review the decision depending on how the growth
trajectory shapes up. The decision not to hike wages may result in increased attrition. Infosys
got itself into difficult situation due to poor planning and account management, in our view.
Infosys is running utilization rate of 64.2%; next year’s growth guidance can be achieved
without meaningful recruitment. However, the company has given 23,000 offers for next
year and has possibly made more commitments for lateral recruitments.
Infosys had two options on the issue of compensation—(1) give wage increments and
backtrack on commitment for recruitments, or (2) do not give wage increments and hope
that increased natural attrition aids improvement in utilization. By choosing the second
option, the company has risked loss of employee motivation and left itself vulnerable to
cherry-picking of quality talent by peers.
Thoughts on factors impacting industry and Infosys
Infosys has failed to protect its turf in the increasingly difficult industry environment. We
detail some of the thoughts specific to Infosys as well the sector
` Protecting profitability in mature relationships. Infosys has historically done an
excellent job in opening new relationships and growing them up to a particular size.
However, the company has struggled to retain its share of business once the client
matures to a certain size, especially in recent times. Large clients’ increased comfort on
offshore vendor/program management may drive them to seek reduction in total cost of
ownership and/or flexible contract structures—this is likely driving market share loss for
Infosys, whose higher-than-peers profitability focus could be hurting them.
` BFSI and TSP verticals have slowed down. In addition to lower incremental business
from these verticals, an additional impact could be intensified competition for the same
pie, which could drive pricing pressure in some accounts.
` Incumbents now better-geared to protect market share. Offshore delivery expansion
of large incumbent SIs has failed to derail the Indian IT services growth story in the past.
Having established a sizable offshore delivery footprint (in India and a few other low-cost
locations), it is entirely plausible that large incumbent global SIs (especially Accenture and
IBM) are doing a better job protecting their market share.
` Visa challenges impacting demand fulfillment. Our channel checks indicate a sharp
increase in L-1 visa rejections and increased delays in H1-B visa processing in recent
months. We understand the futility of our argument that visa challenges are impacting
growth in light of Infosys’ historically low utilization. However, we believe visa challenges
are impacting business selectively across the Indian IT companies.
To sum up, Infosys’ higher-than-peers inflexibility on pricing and contractual structures may
be hurting the company on growth, even as there are a few industry-wide challenges
impacting all and sundry.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
http://www.kotaksecurities.com/pdf/indiadaily/indiadaily16042012.pdf
Infosys: Disappointing; no apparent positives
` 4QFY12 - weak on all counts
` 'No guidance' may have been better than FY2013E guidance
` Infosys performance - a mix of company specific and broader industry
challenges
` Prepare for more volatility, ADD rating retained only on inexpensive
valuations
Disappointing; no apparent positives. Infosys results and guidance disappointed on
all counts. Apparent lack of control has undermined the relevance of the guidance;
FY2013E guidance is incoherent and faces the same issues as FY2012. We may have
underestimated execution issues of Infosys but do highlight that spending cuts in two
large verticals, visa issues and competition are playing a part in impacting equilibrium of
the industry. We cut FY2013E revenue growth to 7.5%, EPS to Rs162 and target price
to Rs2,750. Inexpensive valuation prevents a rating downgrade. ADD stays.
4QFY12—weak on all counts
Infosys missed its revenue guidance for the 5
th
consecutive quarter. Revenues declined 2% qoq or
US$35 mn of which BFSI accounted for US$28 mn. Volumes declined 1.5% qoq while pricing was
down 1.3%. Surprisingly Infosys recruited ~5,000 people and now runs business at utilization
(including trainees) of 64%, lowest in many years. This reflects a big gap in business planning or poor
control of operations. Net income of Rs23.2 bn beat estimate but was boosted by high other income.
‘No guidance’ may have been better than FY2013E guidance
Infosys has missed guidance for the past 5 quarters on constant currency. Consistent miss reflects
a weak process for setting the guidance. Unfortunately FY2013E revenue growth guidance
indicates that nothing much has changed on process. Management commentary fails to inspire
any confidence. A high ask rate of 4.3-4.8% from 2Q-4Q to achieve full-year estimate after weak
1Q guidance fails to inspire any confidence. We forecast 7.5% revenue growth for FY2013E.
Infosys performance—a mix of company specific and broader industry challenges
While we do not doubt the opportunity size for the industry, increased competition along with
slowdown in two large verticals for offshore IT (telecom service providers and financial services)
has impacted industry equilibrium. This will translate into more intense competition, disruptive
pricing strategies and shift of business depending on value proposition demonstrated by different
vendors. We discuss some of these aspects in detail on the subsequent pages.
Prepare for more volatility, ADD rating retained only on inexpensive valuations
We cut our FY2013E revenue growth estimate to 7.5% from 12% earlier. Cut in revenue growth
captures loss of share of business to peers—Infosys’ inability to demonstrate value proposition to
clients or inflexibility on pricing may be hurting more than our estimate; slowdown in key verticals
does not help either. We cut our FY2013E EPS estimate by 5% to Rs161.5. We cut target price to
Rs2,750 from Rs3,100 earlier, valuing the company at 17X FY2013E earnings. Inexpensive
valuation (15X FY2013E EPS) prevents a downgrade. ADD
Earnings snapshot
` Revenues of US$1,771 mn, -1.9% qoq, +10.5% yoy (guidance: US$1,806 – 1,810 mn;
KIE estimate: US$1,817 mn)
` EBITDA of Rs28.92 bn, -7.8% qoq, +24.4% yoy (KIE: Rs28.85 bn)
` EBITDA margin of 32.7%, down 100 bps qoq and up 60 bps yoy (KIE: 31.9%)
` Net income of Rs23.16 bn, down 2.4% qoq, +27.4% yoy (KIE: Rs22.58 bn)
` EPS of Rs40.54/share
Guidance – FY2013E and 1QFY13E
` FY2013E revenue growth – 8-10% US$ terms (KIE estimate was 9-12%), 13.9-16.0% Re
terms
` FY2013E EPS – Rs158.76-161.41/share, up 9.1-10.9% yoy (KIE estimate was Rs159-
166/share)
` 1QFY13E revenue growth – 0-1% qoq (KIE estimate was 2-3%)
` FY2013E revenue guidance implies a CQGR of 4.3-4.8% over 2Q-4QFY13E
` Guidance assumes EBIT margin decline of 70 bps yoy (versus 29% in FY2012) and a
Re/US$ rate of 50.88 (versus 48.23 realized in FY2012)
Key operating metrics and other highlights
` Constant currency revenue decline of 2.1% qoq; cross-currency uplift of 20 bps
` Volume growth – down 1.5% qoq
` Constant currency pricing – down 0.4% onsite, down 1.8% offshore, down 1.3%
blended
` End-period headcount of 149,994, a net addition of 4,906 qoq; quarterly annualized
attrition at 15.6%, down from 17.8% in the previous quarter
` Utilization (ex-trainees) down 570 bps qoq to 70.7%; utilization (including trainees) down
340 bps qoq to 64.2%
` Vertical mix – disappointing across the board, BFSI in particular
` Geographical mix – 4% qoq decline in North America. Europe was flat
` Client metrics – weak across the board
` End-period cash balance – a little over US$4 bn
` Final dividend of Rs22/share and a special dividend of Rs10/share, taking the total
dividend for FY2012 to Rs47/share. Ex-special dividend payout of Rs37/share for the year
implies a dividend payout ratio of 25%
` The total outstanding hedges as of Dec 31, 2011 was US$889 mn (up from US$847 mn
at the end of the previous quarter)
Decision against wage increase may backfire; better option was to backtrack on
hiring commitments
Infosys has decided against a wage increase for FY2013 per the normal April cycle. The
company has indicated that it would review the decision depending on how the growth
trajectory shapes up. The decision not to hike wages may result in increased attrition. Infosys
got itself into difficult situation due to poor planning and account management, in our view.
Infosys is running utilization rate of 64.2%; next year’s growth guidance can be achieved
without meaningful recruitment. However, the company has given 23,000 offers for next
year and has possibly made more commitments for lateral recruitments.
Infosys had two options on the issue of compensation—(1) give wage increments and
backtrack on commitment for recruitments, or (2) do not give wage increments and hope
that increased natural attrition aids improvement in utilization. By choosing the second
option, the company has risked loss of employee motivation and left itself vulnerable to
cherry-picking of quality talent by peers.
Thoughts on factors impacting industry and Infosys
Infosys has failed to protect its turf in the increasingly difficult industry environment. We
detail some of the thoughts specific to Infosys as well the sector
` Protecting profitability in mature relationships. Infosys has historically done an
excellent job in opening new relationships and growing them up to a particular size.
However, the company has struggled to retain its share of business once the client
matures to a certain size, especially in recent times. Large clients’ increased comfort on
offshore vendor/program management may drive them to seek reduction in total cost of
ownership and/or flexible contract structures—this is likely driving market share loss for
Infosys, whose higher-than-peers profitability focus could be hurting them.
` BFSI and TSP verticals have slowed down. In addition to lower incremental business
from these verticals, an additional impact could be intensified competition for the same
pie, which could drive pricing pressure in some accounts.
` Incumbents now better-geared to protect market share. Offshore delivery expansion
of large incumbent SIs has failed to derail the Indian IT services growth story in the past.
Having established a sizable offshore delivery footprint (in India and a few other low-cost
locations), it is entirely plausible that large incumbent global SIs (especially Accenture and
IBM) are doing a better job protecting their market share.
` Visa challenges impacting demand fulfillment. Our channel checks indicate a sharp
increase in L-1 visa rejections and increased delays in H1-B visa processing in recent
months. We understand the futility of our argument that visa challenges are impacting
growth in light of Infosys’ historically low utilization. However, we believe visa challenges
are impacting business selectively across the Indian IT companies.
To sum up, Infosys’ higher-than-peers inflexibility on pricing and contractual structures may
be hurting the company on growth, even as there are a few industry-wide challenges
impacting all and sundry.
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