1. Jefferies rates Infosys as ‘Buy’; valuation inexpensive, even a quarter’s beat could see rerating

Jefferies rates Infosys as ‘Buy’; valuation inexpensive, even a quarter’s beat could see rerating

Recent commentary suggests no further reset of guidance and confidence in sustained operational improvements.

By: | Published: November 28, 2016 6:07 AM
Infosys is now trading at near 5 yr trough valuation. Even a quarter’s beat at current low expectations could trigger a rerating with further upsides from growth revival in FY18E. Infosys is now trading at near 5 yr trough valuation. Even a quarter’s beat at current low expectations could trigger a rerating with further upsides from growth revival in FY18E.

Recent commentary suggests no further reset of guidance and confidence in sustained operational improvements. Stock has been impacted by: structural issues (digital/cloud transition); cyclical (US elections, banking slowdown); and regulatory (US immigration reforms post-Trump win). Strong deal wins cushion against cyclical headwinds and immigration reforms (if any) likely to be benign vs current concerns. Expectations are low and valuations inexpensive.

Recent commentary—no deterioration in demand

In its recent commentary, Infosys has maintained its full year guidance of 7.5%-8.5% y-o-y growth in USD terms and 24%-26% Ebit margin guidance for the year. Company has maintained its confidence in operational improvements and continued tweaking margins levers (subcontracting costs, onsite mix, utilisations). Over a longer term, automation benefits should help in both company’s positioning with clients as well as margins although the path towards software + services model is likely to be riddled with volatility.

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Set up similar to 2012 US elections which was followed by a sharp revival

From a cyclical standpoint, the current set up is very similar to that in 2012 where spending uncertainty in the run-up to US presidential elections along with Eurozone crisis had caused a significant slowdown of growth followed by an equally fast revival in 2013. Mgmt has commented that client spending has been lower than budgeted this year with savings from cost-out initiatives not spent due to macro factors.

Catalysts and 2H growth drivers

FY17E guidance of 7.5%-8.5% YoY growth implies no growth in 2H and vs the business heads own commentary in the quarter results seemed conservative. Despite this and low expectations, the key variables in 2H17 are; extent of revenue loss in RBS contract, our est c.$60 m; positive impact of GST contract ramp up; US poll outcome impact not baked into guidance; ramp up of large deal wins where company has indicated some slowness in recent past.

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Valuation/risks

Infosys is now trading at near 5 yr trough valuation. Even a quarter’s beat at current low expectations could trigger a rerating with further upsides from growth revival in FY18E. Despite the recent slowdown, execution on margins and key operating metrics has been robust. Our 12M PT is based on 18x PE applied to FY18E EPS (unchanged, same as target multiple for TCS). Maintain Buy, remains top sector pick. Risks: Weak macro, high competition, cross currency, stronger INR.

Target Investment Thesis

Higher focus on growth from the company evident in new client additions, incremental business from top accounts and deal win momentum. Growth trajectory likely to improve on the back of sales focus and improved execution in FY18E, post guidance reset for FY17E. Mar 17e/18e EPS: Rs 63.5/71.4; Target Multiple: 18x; Target Price Rs 1,280.

Upside Scenario

Macro environment improves with discretionary spending coming back. Revenue growth estimate of low teens CAGR (USD terms) over FY16-19E. Margin to sustain at 28%, high end of company-indicated range. Mar 17e/18e EPS: Rs 73/82; Target. Multiple: 20x; TP Rs 1,640.

Downside scenario

Macro environment deteriorates and snowballs into a crisis-like situation. Revenue growth estimate of <8% CAGR (USD terms) over FY16-19E. Margin falls another 100 bps as growth is difficult to come by. Mar 17e/18e EPS: Rs 54/61; Target Multiple: 12.5x; Target Price Rs 760.

Other considerations

The Indian IT industry is export-oriented; as a result, the fortunes of the sector are heavily dependent on global macroeconomic conditions. We have assumed that the current stability will continue for some more time; however, we have not assumed a crisis-like situation (as seen in 2008). In addition, the reported numbers are impacted by the exchange rates (especially USD/ GBP/EUR).

Catalysts

1) Growth trajectory improves backed by strong sales execution. 2) Pipeline continues to improve on the back of strong deal win conversion. 3) Efforts on automation are monetised yielding gains on margins and offsetting the pricing pressures. 4) More efficient capital allocation and inorganic efforts bear fruit.

Company description

Infosys is the second largest Indian IT company and a leader in offshore services space. It provides consulting, application development & maintenance and engineering services across verticals such as banking & financial services, insurance, manufacturing, telecom, retail and utilities in the Americas, Europe & Asia Pacific.

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