1. ‘Overweight’ rating on Infosys: Weak revenue masks positives

‘Overweight’ rating on Infosys: Weak revenue masks positives

Guidance, moderation in attrition and good employee addition point to recovery efforts.

By: | Updated: May 4, 2015 9:44 AM

Rating: Overweight

Infosys reported 0.4% quarter-on-quarter constant-currency (cc) revenue decline (down 2.6% q-o-q in $ terms) in Mar-15, which is below our expectation of 2.0% cc growth. Weakness was seen across most segments and geographies (maxi- mum in energy and utilities). The revenue decline is mainly due to a decline in realisations, which we believe is a structural concern.


FY16 cc revenue growth guidance of 10-12% is just above our expectation of 9-11% year-on-year; it seems slightly aggressive in the face of the weak exit in Q4FY15. Infosys needs to deliver 3.1-3.8% q-o-q revenue growth in all four quarters of FY16, while it has reported 3%+ q-o-q (cc) revenue growth just four times in the last 13 quarters. Ebit (earnings before interest and taxes) margin of 25.7% is broadly in line with our/street expectation of 26.0%. Dividend payout ratio increased to 50% of profit after tax (from 40% now), but the company has not laid out any plans to return the significant existing cash or continually accumulate cash.


The silver linings in the quarter include significant decline in attrition (for second straight quarter) with quarterly annualised attrition reaching a nine-quarter low and the highest employee addition (net addition of 6,549) in the last 14 quarters. We believe that the reaction of the stock to the results (down 6%) suggests that the street is not placing much faith in Infosys’s guidance, believing it to be aggressive given the ask rate.

Infosys reported Q4FY15 revenues of $2,159 million, much below our and consensus expectation of $2,220 million (a miss of $60 million). It reported q-o-q USD revenue decline of 2.7% much below our expectation of flattish revenues. Cross-currency caused revenue growth headwind of 230 bps; hence, constant-currency decline of 0.4% q-o-q. The company issued FY16 cc revenue growth guidance of 10-12%, which seems slightly aggressive.

Given that cross-currency is likely to cause y-o-y growth headwind of about 300 bps, implied USD revenue growth guidance is 7-9%. Infosys needs to deliver 3.1-3.8% revenue CQGR (compounded quarterly growth rate), which could be difficult to achieve.

Mar-15 quarter margin is broadly in line. Ebit margins decreased about 100 bps to 25.7%. vs. street expectation of 70 bps. Ebit margin moderation is solely due to higher G&A expenses. Gross margins rose 30 bps q-o-q despite a decline in realisations, cc margin headwinds and decline in utilisation. SG&A (selling, general and administrative expenses) as a percentage of revenues remain at 5.5%, in line with Q3FY15. Notably, utilisation (ex trainees) decreased from 82.7% in Dec-14 quarter to 78.6%.

Q4FY15 revenue decline is driven by moderation in realisations. Constant-currency blen-ded realisations declined 1.7% q-o-q for yet another quarter. Onsite realisation fell 2.3% q-o-q in cc terms, while offshore realisations declined 2.0% q-o-q cc. We expect pricing pressure to be a worry for the sector near term. Pricing pressures in Infrastructure management-oriented, rebid deals have intensified as per our deal checks. Though Indian IT players are bringing more automation in their delivery, due to competitive pressures they end up giving most benefits back to clients in the form of lower pricing, thus limiting margin benefits.

Broad-based revenue growth weakness in Mar-15 quarter. North America, Europe and India, all major geographies reported constant-currency q-o-q decline in revenues in Q4FY15, while RoW (rest of world) reported flattish revenues. In terms of verticals, ECS (energy & utilities, communications & services) and RCL (Retail, Logistics, CPG and Life Sciences) report meaningful decline in revenues in cc terms. However, manufacturing and financial services saw a modest increase. Except testing and BPO, all major service lines saw sequential decline in revenues (in USD terms).

Investment view. For recovery stories such as Infosys, we believe it is appropriate to monitor the leading indicators of improvement than just revenue recovery. In this context, we see the leading indicators of improvement at Infosys over the coming 3-4 quarters reflected in declining attrition, increased net hiring, sales & marketing investments and progression in client mining.

Valuation: We stay OW (overweight) on Infosys with a Dec-15 price target of Rs 2,300.

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