'Neutral' rating for Infosys Ltd share price, says Credit Suisse

Updated: Jan 20 2014, 20:06pm hrs
InfosysInfosys Ltd attrition a concern; improvement in margins, utilisation and offshore mix... (AP)
Infosys Ltd margins surprised positively in Q3...: While margins were expected to be stronger, they still surprised positively. Margins--adjusted for the $35m visa-related settlement charge in Q2--were up 140 bp q-o-q to 25%, ahead of street expectations. This was driven partly by an improvement in utilisation (headcount has come down quarter-on-quarter), improvement in the offshore mix and some improvement in SG&A (selling, general and administrative expenses) expenses.

Some of it has come through cost controls and not all of that is positive in the medium term but there have been operational improvements as well. Infosys Ltd gross margins rose 80 bp but sales and marketing expenses fell 60 bp after rising in the previous quarter.

Quote: Infosys Ltd

Infosys Ltd has increased proportion of revenues delivered offshore by 140 bp q-o-q to 48.9%. Overall utilisation excluding trainees went up 20 bp q-o-q to 78%. Utilisation in the IT services and consulting segment dropped 60 bp q-o-q.

though revenue growth remains muted: Revenue increased 1.6% q-o-q to $2,100m and grew 1.2% q-o-q in constant currency terms. Revenue though was a bit light and the implied Q4 guidance would mean continuing underperformance relative to top peers. Guidance (FY14 revenue growth guidance has been changed to 11.5-12%, up from 9-10%) suggests -0.4% to +1.4% growth in the March quarter.

Infosys Ltd financial services seems to have picked up. The business momentum in manufacturing seems stable. Hi-tech remains weak. The energy segment appears stable. Telecom remains challenged and the management expects cuts in IT budgets. The pipeline in retail, CPG (consumer packaged goods) and logistics seems strong driven by cloud, infra, BI (business intelligence), analytics, and ERP-led transformation projects. In life sciences, the 'patent cliff' seems to be opportunities for large outsourcing deals + ERP-led transformation. Commentary on the environment by management has been quite positive. Given that Infosys has traditionally been more cautious in the past relative to peers, this stance can be construed as a positive takeaway for the sector.

We remain concerned on HR-related issues: There have been some senior management resignations recently. We see such flux as a serious concern in the medium term. Any further resignation needs to be watched out and these cannot be ruled out given the recent change in the organisational structure, the disbanding of the executive council and some recent cost-cutting moves.

Infosys Ltd attrition continues to move up. Last LTM (last twelve months) attrition went up 80 bp q-o-q to 18.1%. In comparison, TCS' attrition is around 10%. The management appears to be considering reverting to implementing annual wage increases in April, despite the last increase (delayed) in July. While this will have implications on margins, we think this is a positive move.

Other operating metrics: Billed volume increased 0.7% q-o-q and blended realisation was up 0.7% q-o-q (onsite: +2.2%, offshore: +2.2%) in USD terms. Revenue from the top client decreased 3.6% q-o-q in USD terms but there may not be much to read in this given quarterly volatility around these metrics. Revenue from financial services was up about 2% q-o-q. Operating cash flow was $438m in the quarter; down 21% q-o-q, 9% y-o-y.

We have revised up our FY14-FY16 estimates by 1-2% to reflect Q3 actuals and we roll forward our TP (target price) to Rs 3,800 (earlier Rs 3,400). In an environment where we believe that the tailwind for the sector is good, we continue to prefer HCL Technologies and Tata Consultancy Services, where we see little risk.