INFY Recommendation ACCUMULATE Target Price Rs. 2260 :: Kotak Securities

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INFY
Recommendation ACCUMULATE	Target Price Rs. 2260

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Volume growth of 4.2% in a seasonally weak quarter was a surprise.
Margins beat estimates but largely due to lower provisioning on doubtful
debts. On important parameters, the annualized attrition rate has eased to
21.5% in 3Q v/s 25% in 2Q. Client penetration has also improved QoQ and 3
large deals have been signed. On newer initiatives, 9000 employees have
been already trained on Design Thinking and 1000 developers on Machine
Training. We believe that, these initiatives will shore up the growth rates of
Infosys and sustain margins over the longer term, while having some
impact on profitability in the short term. Guidance in CC terms has been
maintained, we understand. With the developed economies growing /
stabilizing, we do expect the demand scenario to improve over the next few
quarters. Our FY16E EPS stands at Rs.122 (Rs.121) and TP at Rs.2260 (Rs.2239).
ACCUMULATE (Buy at Declines).

IT services revenues grew by 2.5% in CC terms
 Revenues grew by 0.8% QoQ in USD terms. In CC terms, they were higher by
about 2.6% QoQ (3.9% in 2Q).
 Revenue growth was helped by the IT services business, wherein CC revenues
grew by 2.5% QoQ. Volumes in IT services grew by 4.2% (3.9% in 2Q) and
came in higher than estimates.
 The volume growth looks more impressive when seen in the back drop of a seasonally
weak quarter.
 The 4.2% volume growth was the best in the last three years and the best 3Q
growth in past 6 years.
 We are encouraged by the third successive quarter of good volume growth in IT
services. 1QFY15 had seen a 2.9% rise in volumes QoQ.
 Average realisations were down by 350bps in reported terms and by 170bps on
a CC basis.

 The 1.7% CC drop came partly on the back of the lower number of working
days. These impact the rates which are in monthly terms.
 However, we note that, Infosys has been giving favourable terms to strategic clients,
which has led to pressure on blended realisations over the past few quarters.
 The management has already indicated pricing pressure in non-discretionary
business which is 2/3rd of its revenues.
 Infosys has started re-aligning its strategy and has become more flexible in its
approach to get a higher market share. To that extent, we will be watchful of
realisations in future quarters.
 While IT services revenues grew QoQ, product revenues also grew by 3.4% in
INR terms.
 Product revenues are still below the 2QFY12 numbers, indicating the lack of
scale up in this business. We note that, the past two years have been challenging
for discretionary spends, including products. The business has seen a management
change with a new CEO being appointed recently.
Client additions / penetration; large deals
 Infosys added 59 clients during the quarter.
 In terms of client penetration also, the number of clients in the $50mn, $75mn,
$100mn and $200mn brackets grew by 3, 2, 1 and 1, respectively.
 We believe that, Infosys will be increasing its wallet share with its clients while
engaging with new clients, in the future. We note that, Infosys has enhanced its
sales network over the past two quarters, towards this end.
 The company has added more than 300 people to its sales force (about 20%
addition), of which 150 have come in from the delivery teams.
 Infosys won 3 large deals (>50mn TVC) in 3Q, as compared to 7 in 2Q.
 The company added various other deals which were slightly lower in magnitude.
However, we believe that, Infosys will scale up its large deal activity in the future
quarters and it already has a strong pipeline.
 We maintain that, Infosys has become more flexible in offering terms to clients,
over the past few quarters.
 The company had under-performed peers in the past due to its focus on sustaining
profitability, even at the expense of revenue growth. This is changing. However,
we do understand that, Infosys will aim at sustaining margins its stated
range of about 25%, in the medium term.
Margins beat estimates for the third successive quarter; lower
provisioning helped
 EBIT margins improved by about 63bps QoQ. While currency fluctuations impacted
margins positively to the extent of 70bps, lower utilization rates also
helped.
 However, these were set off by promotions to 5000 employees, salary increments
to specialists and also holiday allowances. Infosys also added 4227 employees
on a net basis. Thus, it has made investments in business.
 Margins improved by about 70bps due to write back of provisions for doubtful
debts (30bps positive in 3Q v/s 40bps negative in 2Q). This may not be a sustainable
number.
 Over the past two quarters, Infosys had positively surprised on margins. In 2Q,
margins had improved despite additions of 4127 employees on a net basis, the
highest in the past 10 quarters. Infosys had also given promotions to 12000 employees
and 100% variable pay (after several quarters).

 This makes the margin improvement in 9mFY15 more impressive.
 With Infosys pushing for growth as well as training of employees, there may be
higher spends towards these.
 However, we believe that, higher revenue growth, better realisations (non-linearity)
and leverage on costs should help in sustaining margins in FY16.
 The management expects margins to remain at around 25% in the medium
term. If the company reaches industry growth levels, margins could move up to
between 25% and 27%, according to the management.
Initiatives towards the strategic vision to yield results in long
term
 In the 2QFY15 analyst call, Dr. Vishal Sikka had laid down his vision to convert
Infosys into a new-age services company, having higher proportion of non-linear
revenues.
 The focus of Infosys is on renewing all existing services while introducing new
products / services in an eco-system of various alliances with vendors, start-ups,
etc. Education / training of employees on these initiatives will be the foundation
of this strategy, which Infosys calls - Human Revolution.
 The new strategy is aimed at improving employee productivity which currently
stands at $53000 per employee.
 With these new initiatives, Infosys is targeting to achieve growth rates of 18%-
20%, with margins of 25% - 28% on a sustainable basis, over the long term.
 The company has already started the process and has trained 9000 people on
Design Training (DT) including work-shops for 400 senior executives.
 It is doing DT workshops with 25 clients already.
 The sales team is also being retrained and redirected. 70% of the front-end consultants
have been trained. Infosys is looking at automating some portions of the
sales process.
 In Artificial Intelligence, Infosys has trained 1000 people in a 3-week course and
plans to train an additional 500 every quarter.
 Infosys has aggressively added employees in several of the new services. Over
the previous quarter, the workforce has increased by more than 59% in big data
/ analytics, 13% in cloud and 4% in cloud.
 It has already worked on 56 Big Data projects.
 Infosys has also increased the size of its innovation fund from $100mn to 500mn.
This fund will actively look at investing in or partnering with start-ups within and
outside India.
 We opine that, Infosys is taking concrete steps towards achieving its long-term
objectives. However, we believe that, the strategy will have an appreciable impact
on financials only over the longer term.
 The management will provide further information on likely investments, the short
term impact on margins, etc by the next quarter.
Macro scene - no major changes over 2QFY15 end
 The management has indicated that, the macro scene remains largely unchanged
v/s 2Q. Various verticals continue to face headwinds.
 Infosys continues to see pressure on discretionary spends by clients, excluding the
digital initiatives. The focus on the clients continues to be on cost optimization
and efficiency increases, which has improved the pipeline better in traditional
services.

We factor in 7% YoY growth in USD terms for FY15 and about
13% in FY16
 Infosys has maintained the guidance for FY15 in CC terms. With the sharp crosscurrency
movements in 3Q, the guidance in USD terms is lower.
 We expect the company to end the year with a 7% USD revenue growth in
FY15 and 13% in FY16.
 We assume the exchange rate to be at Rs.61 / USD in FY15 and 60.5 / USD in
FY16.
 We expect margins in FY15 and FY16, to be better than FY14. Salary hikes and
increased S&M expenses will likely be more than set off benefits from utilization
increases, improved efficiencies, higher off-shore content and cost rationalization
initiatives. Higher revenues from non-linear initiatives should also help.
 With tax rates expected to be at about 27% of PBT in FY16, PAT is expected to
be at Rs.139bn in FY16 (Rs.138bn earlier). EPS works out to 122 for FY16 (Rs.121
earlier).
Valuations and recommendations
 We have been positive on the long-term demand prospects for quite some time.
With the developed economies (especially US) stabilizing, we do expect the demand
scenario to improve over the next few quarters.
 The margins for Infosys seem to be improving ahead of our expectations.
 The new strategy should allow Infosys to improve growth rates over the long
term with sustained margins.
 Our TP stands at Rs.2260. We recommend buying the stock at declines. ACCUMULATE.
Concerns and risks
 A slower-than-expected recovery in major user economies may impact our projections.
 A sharp appreciation of rupee beyond our assumed levels may impact our earnings
estimates for the company

INFY
Recommendation ACCUMULATE	Target Price Rs. 2260

LINK

http://www.kotaksecurities.com/pdf/pdfs/FUNDINFY12012015093620.pdf