Reduce rating on Infosys, target Rs.2,350

Updated: Nov 21 2012, 05:45am hrs
We remain cautious on Infosys and Tier-1 IT services companies. We have a reduce rating on Infosys with a target price of R2,350. Infosys commentary on demand environment continues to be a tad contrasting to its industry peers. The company continues to see the demand environment as challenging across most verticals and geographies, even as there are pockets of optimism.

Demand environment in Europe remains particularly challenging, while that in North America is mixed with some sectors tracking fine.

Increasing centralisation of decision-making and involvement on multiple CXOs on IT spend decisions have led to elongated decision-making cycles. Clients remain cautious on committing funds to large discretionary programmes this has to do with continued lack of confidence on revenue growth across sectors in developed markets, even as balance sheets are healthy and cost structure under control.

In our conversation with the new CFO, Rajiv Bansal, we could understand that clients, greater involvement of third-party advisors, intensified competition among Tier-1 vendors and increasingly challenging supply-side differentiation have all led to sustained commoditisation (essentially price-point based decision-making by clients) of several traditional non-discretionary service lines like AM and transactional BPO.

There is deal activity in the market, providing opportunities for growth. The challenge is that a lot of these opportunities come with a margin tradeoff and/or a need to use the balance sheet. However, the tradeoff has not showed up in relative margin performance companies growing faster have done better on margin performance as well.

Even as Infosys remains committed to its aspirational revenue mix target set under the broad Infosys 3.0 strategy, it is cognisant of the timing challenges to the pursuit. Demand for discretionary services remains weak; industry growth is essentially coming from large renewal deals in traditional services (primarily IMS). After refraining from participating aggressively in this market given the dilutive impact on profitability, the company indicated that it has become a bit more flexible on this front. The company indicated that it remains averse to low NPV deals involving upfront cash and/or asset/employee takeover.Kotak Institutional Equities