Infosys Are we still convinced? : Espirito Santo

Infosys has consistently disappointed the street for almost 6 quarters
now. By any stretch of the imagination that is a long wait for a
company like Infosys to deliver and it has tested investor’s patience
on the resumption of growth. However post Q1FY13 we are
incrementally convinced that growth will resume sooner rather than
later. Our core thesis has been that we are seeing Infosys become
more flexible on price and less averse to risk in the commoditized
area of the business, in an effort to drive volume growth and boost
utilization rates which are now close to historic lows. Q1FY13 results
build on our thesis with volume growth at 3% v/s street expectations
of flat volumes. The decline in pricing is largely like-for-like and
broad based which indicates that better volume growth and
improving utilization will follow. We reiterate BUY.

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Expect improved focus on commodity biz to yield results
In our recently published initiation thematic, our key investment argument for
Infosys was that it was back on twin engines – the commodity (ADM) segment
as well as the high margin (consulting and SI) segment - after realising that it
had lost sight of near term realities. While revenues in this quarter were held
back due to cancellation of a transformational project, the concern is can
Infosys get back to top quartile growth rates of the past? We continue to think
so:
1. Pricing decline should drive volume growth: We understand that Infosys
has seen a like-for-like pricing decline of at least 2% QoQ after adjusting for
i)cross currency (60bp) and ii) $15m impact due to cancellation of a
transformational project by an European Utility firm (80bp) and iii) shift in
portfolio mix (20bps). We believe that large scale pricing re-negotiations in
key accounts has happened, which led to 2% like for like drop in pricing
which will eventually drive volumes in H2FY13. While it is well placed to
drive growth when the environment improves, we see increasing realisation
within Infosys that it can no longer lose share in the commodity segment.
2. 5% growth guidance builds in possible future ramp downs: Given two
back to back misses in quarterly revenues and discontinuation of quarterly
guidance, a genuine concern is whether “at least 5%” growth is possible or
even that is at risk now. Our conversation with the company indicates that
the revenue growth guidance of 5% in FY13 factors adequate ramp downs
in the BFS segment (if at all) in H2FY13. Infosys has been mentioning that
some BFS clients could relook at their budgets in H2 of CY12 and it has
identified problem accounts and has built in adequate provision in those
accounts in arriving at ‘at least’ 5% revenue growth for the full year.
3. Margin to improve with growth; wage hike only if growth improves: We
expect margins to improve with increasing volume growth (we estimate
10% headroom to utilization over time). Our expectations of improving
volume growth are predicated on the broad based pricing declines driving
share gains. Conversations with the company also indicate that wage hikes
are unlikely in FY13 until there is a significant improvement in growth.
Valuation: Why give 14x multiple when growth is 5%?
Our view of a re-rating in multiples for Infosys is driven by our conviction of
improving growth. We note that in the past volume growth returned post
decline in pricing. For instance growth in FY10 picked up after two consecutive
quarters of pricing declines (pricing fell by 6% and 3% in Q3 and Q4FY09
respectively). With revenue decline and price cut already in place, we expect
revenue growth to gather steam. Reiterate BUY.