Infosys CEO’s comments elaborate the technology transitions and try to capture the mantle of thought leadership. We believe that Infosys, like most of its peers, has taken only initial steps in this differentiation journey and it is too early to call this a success (or failure). However, other initial signs under the new CEO have been encouraging as sales execution and large deal wins have materially improved revenue trajectory for the company. Maintain Buy.
Growth has been robust in FY16. Revenue growth (+17% y-o-y in INR, +9% in USD). improved in FY16, on strong sales execution and large deal wins. Acquisitions – Panaya, Skava/Kallidus and Noah would have contributed to ~100bps growth, in our view. Growth was led by North America by geos and Life Sciences by verticals.
Margin headwinds due to increases in subcontracting and in growth areas. Increase in subcontracting costs was the largest headwind to margins alongside third party items , overall gross margins 53bps y-o-y in FY16. Key growth areas—N America, financials and retail saw the biggest margin contraction, and should keep the growth vs margin debate intact.
Client and employee metrics improve. The improvement in deal wins evident from total contract value (TCV) of deal signings +44% y-o-y has led to improvement of large client buckets with traction also evident in client additions. On employee metrics, the company has made the largest net addition of employees in past four years in FY16. Attrition has declined 530bps y-o-y to 13.6%.
Receivables stable, watch for deferred contract costs. On a y-o-y basis, receivable cycle has been stable in FY16 with an improvement in ageing profile of debtors. It has booked deferred contract cost of R3.3 bn under loans and advances. While not a significant number currently, this will need monitoring given the high competitive intensity in the market.
Our 12M target price of Rs 1,390 is based on 18x P/E applied to FY18e EPS, at a premium to peers. Maintain Buy. Infosys remain our top sector pick with valuation premium being well justified by industry leading growth in FY17e.
Risks: Weakening macro, higher competitive intensity, unfavourable cross currency, stronger INR.