Core svcs growth sloweven considering offshore shift
We expect near-term margins to improve, but expect downward pressure in
medium-term from aggressive pricing, renewed S&M investments and wage hikes.
Though margin improved much ahead of expectations, we see some worrying
signs with 62.3% of incremental rev. coming from Lodestone and vol growth of
just 0.7% for IT Svcs incl. Consulting (excl. BPO and Finacle). We continue to
believe that Infosys will lag peers in terms of revenue growth over FY15E, we think
that the sharp de-rating we had worried about is not imminent given the margin
improvement this qtr and upgrade to HOLD with a 1-Year TP of Rs3,490.
Offshore shift, headcount cut, S&M cost cuts, help push margins up: Margins
were significantly ahead of our expectations with price realization improvement a
pleasant surprise, we were surprised at the 1.1% decline in HC and S&M employee
costs that have (at USD84.3Mn) gone back to absolute levels seen in 1QFY14
(USD83.8Mn). Near-term margins can expand further with utilization and fresher
intake; large deal pursuits will involve increasing S&M spending as these typically
involve bid spends of 1-1.5% of TCV (total contract value).
Lodestone-driven growth disappoints despite USD24Mn offshore shift drag:
We note that even as Lodestone added USD21Mn even over 3QFY13, Consulting &
Pkg implementation added only USD13Mn, suggesting a decline in existing run
rate (though perhaps partly explained by offshore shift). Also disappointing was the
USD11Mn decline in US run rate and only USD6Mn addition in Europe excl.
Lodestone. It was disappointing to see vol growth at just 0.7% for IT Svcs &
Consulting excl. BPO and Finacle (in 3QFY13 it had organic vol. growth of 1.5%).
Sales and employee pyramid broadening strategy tough to execute: Given the
new focus on large deals, we had expected there will be some senior hires in the
sales side as well as the technical workforce. But comments from the mgmt.
suggest sales investments at the bottom of the sales pyramid and for technical
workforce, the fresher heavy-hiring pattern continues. We think thatskills needed
to bid, structure and manage large IT Outsourcing deals are more of an art that take
years of exp. and more lateral hiring will be needed than currently.
No de-rating worries for now:Given the sharp margin and pricing improvements,
we increase our margin estimates for FY14E and FY15E even as we reduce rev.
estimates marginally. We remain concerned about its ability to win large ITO deals
and in new areas of discretionary spending and expect the P/E discount to TCS will
widen given the growth differential. But with pricing and margin improvement, we
think a sharp de-rating is not imminent and increase our target P/E to 14x (earlier
12x) and arrive at a new 1-Year TP of Rs3,480. Key upside risk is large wins, while
downside risk is pressure on margins through billing rate declines or wage hikes.
��
We expect near-term margins to improve, but expect downward pressure in
medium-term from aggressive pricing, renewed S&M investments and wage hikes.
Though margin improved much ahead of expectations, we see some worrying
signs with 62.3% of incremental rev. coming from Lodestone and vol growth of
just 0.7% for IT Svcs incl. Consulting (excl. BPO and Finacle). We continue to
believe that Infosys will lag peers in terms of revenue growth over FY15E, we think
that the sharp de-rating we had worried about is not imminent given the margin
improvement this qtr and upgrade to HOLD with a 1-Year TP of Rs3,490.
Offshore shift, headcount cut, S&M cost cuts, help push margins up: Margins
were significantly ahead of our expectations with price realization improvement a
pleasant surprise, we were surprised at the 1.1% decline in HC and S&M employee
costs that have (at USD84.3Mn) gone back to absolute levels seen in 1QFY14
(USD83.8Mn). Near-term margins can expand further with utilization and fresher
intake; large deal pursuits will involve increasing S&M spending as these typically
involve bid spends of 1-1.5% of TCV (total contract value).
Lodestone-driven growth disappoints despite USD24Mn offshore shift drag:
We note that even as Lodestone added USD21Mn even over 3QFY13, Consulting &
Pkg implementation added only USD13Mn, suggesting a decline in existing run
rate (though perhaps partly explained by offshore shift). Also disappointing was the
USD11Mn decline in US run rate and only USD6Mn addition in Europe excl.
Lodestone. It was disappointing to see vol growth at just 0.7% for IT Svcs &
Consulting excl. BPO and Finacle (in 3QFY13 it had organic vol. growth of 1.5%).
Sales and employee pyramid broadening strategy tough to execute: Given the
new focus on large deals, we had expected there will be some senior hires in the
sales side as well as the technical workforce. But comments from the mgmt.
suggest sales investments at the bottom of the sales pyramid and for technical
workforce, the fresher heavy-hiring pattern continues. We think thatskills needed
to bid, structure and manage large IT Outsourcing deals are more of an art that take
years of exp. and more lateral hiring will be needed than currently.
No de-rating worries for now:Given the sharp margin and pricing improvements,
we increase our margin estimates for FY14E and FY15E even as we reduce rev.
estimates marginally. We remain concerned about its ability to win large ITO deals
and in new areas of discretionary spending and expect the P/E discount to TCS will
widen given the growth differential. But with pricing and margin improvement, we
think a sharp de-rating is not imminent and increase our target P/E to 14x (earlier
12x) and arrive at a new 1-Year TP of Rs3,480. Key upside risk is large wins, while
downside risk is pressure on margins through billing rate declines or wage hikes.
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