We had a call with Infosys IR Mr. Sandeep Mahindroo on 30 August,
2012. Key takeaways from the call are:
Overall demand – in line with guidance, discretionary demand
remains spotty
The company does not see any broad-based pickup in discretionary
demand; although some pockets like Manufacturing or Retail are holding
up well, while other verticals including BFSI continue to be challenged.
Infosys has not seen discretionary deals getting bundled with cost
efficiency deals.
Cost efficiency segments: ADM – focus on balancing short term vs
long term, IMS – No material increase in focus
Within the cost efficiency segments, the company believes testing is not
an area of concern and they remain positive on the segment. In BPO,
the company continues to focus on high quality growth and has delivered
best in class margins in the space, driven by transformational
engagements which directly impact revenue/costs for clients.
However, in ADM where growth has been sluggish, the company clearly
believes they have seen increased commoditization and are trying to
strike a balance between short-term growth vs long-term strategy of
increasing contribution from higher value added segments. In IMS, which
has been a smaller and less focused segment for Infosys on account of
its reluctance to take on assets or enter into margin dilutive deals, the
company will continue to play selectively on a deal to deal basis.
Stronger activity levels in US (ex of BFSI), Europe activity levels
low ex of some chunky deals
The company, contrary to its expectations at start of the year, has seen
activity levels holding up in US (ex of BFSI), while activity levels have
gone down in Europe (excluding some of the chunky cost efficiency
deals). In ROW, ~50% of Infosys’ exposure is to Australia where they
have seen marginal deterioration in activity as the country is an export
led economy and has been impacted by the strength in the AUD. In
India, it recently signed the India Post Order and some deal activity is
being seen, while China remains in investment phase.
Not being blanket flexible, flexibility more on a case to case basis,
no compromise on guided margins or longer-term aspirations
Infosys is less averse than before in getting into deals that involve 1)
people takeover 2) lower initial margins but with potential to scale up to
company level margins (as long as near-term portfolio margins can be
managed within the guided band) and 3) pricing cut negotiations, if client
initiated on a case to case basis, depending on client importance and
future potential. The company is not looking at being disruptive on
pricing to improve volumes or not looking to be aggressive on margins in
smaller exposure segments like IMS, as this does not fit within their
framework of moving up the value chain. This short-term flexibility is on
account of softness in discretionary demand segments, without changing
their longer-term aspiration, in our view.
Pricing renegotiation instances much lower than last quarter
The company has seen much lower instances of pricing discussions in
this quarter compared to last quarter, where investment banking clients
as well as diversified banks had shown pricing renegotiations. Overall
pricing outlook remains stable, with the one-off impacts of ~80bps on
pricing due to a contract cancellation in 1Q behind them, according to
the management. Overall, from a competitive perspective Infosys says it
has not seen major pricing disruptions or irrationality in pricing.
Sales investment declines over last 3 quarters largely lower
variable payout related, likely to go up as growth improves
Infosys has seen their sales and marketing expenses go down from
USD98mn to USD85mn (reduction of 13%) over the last 3 quarters. The
company attributes the reduction to 1) Lower variable payout as the
growth was sluggish and 2) one-offs due to event participations in
2QFY12. The company sees the variable payouts increase as guidance
builds in improvement in growth in the subsequent quarters. Infosys
S&M as a % of sales had dropped to 4.9% - the lowest over last 12
quarters.
Utilization declines on hiring ahead of demand and fungibility
issues post restructuring, growth key to utilization improvement
Infosys is at a 3-year low in terms of utilization and management
attributes the fall in utilization to 1) decision to hire ahead of demand
post missing out on growth around 2QFY11 due to high utilizations then
2) Issues with fungibility of resources across their 4 verticals (BFSI,
Retail, Manufacturing, Energy, communication and services) which are
seeing divergent demand trends. There was a 12-month moratorium
period post restructuring (Apr 2011), when resources were not allowed to
be moved from one vertical to another. The company believes though
resource fungibility has improved since then, it is not likely to be a
material utilization lever, as growth is key for this metric to improve.
Management expects flattish utilization trends in the near term as fresher
hiring commences from 2QFY13F onwards. The company intends to
absorb the freshers up to 1QFY13 (a one quarter extension compared to
the usual), which is also built in its guidance. At onsite, utilizations have
come down to lower than 90% levels on 1) consulting led hiring
(impacted by soft demand) 2) greater localization. The company expects
to be closer to its target of hiring ~1,200 local resources in the US by 2Q.
Nomura view
Post our interaction we are still not convinced on:
Lag reduction with peers in cost efficiency segments, despite
being slightly more flexible as that is likely to be to save volume share
and not drive significant incremental volumes in these segments
Any material improvement in discretionary segments, where
Infosys exposure continues to be higher than peer group.
We continue to remain cautious on Infosys on 1) The company growing
slower in cost efficiency segments both on higher margin thresholds and
mix issues with a smaller/less focused IMS practice 2) High discretionary
dependence impacted by macro uncertainty 3) overhangs of visa related
inquiries and 4) High dependence of 2H deal flow for street and our
double digit growth expectations to be met.
We believe these issues while not irreversible, are unlikely to be
resolved immediately. We expect USD revenue growth of 4%/10% over
FY13/14F and EPS CAGR of 9% over FY12-14F, lowest among tier 1
IT. We continue to prefer market share gain focused players like HCLT,
CTSH and TCS over INFO. INFO remains our least preferred stock in IT.
The stock trades at 14.6xFY13F and 13.9x FY14F earnings. Maintain
Neutral and TP of INR2260 (downside 5%).
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