India Inc Q4FY14 results a mixed bag

Updated: Apr 21 2014, 19:57pm hrs
InfosysGood Q4 margins and a reasonable strong FY15 guidance (despite the recent profit warning) were positives. Reuters
The Q4FY14 results of Infosys were a mixed bag. Good Q4 margins and a reasonable strong FY15 guidance (despite the recent profit warning) were positives. On the other side, deteriorating client mining (chart 3) and high attrition (chart 2) remain matters of concern. We believe the Street has provided negligible probability for the company to achieve the top end of the guidance (9% growth), which requires nearly 3% CQGR (compound quarterly growth rate) in the next four quarters. This is a positive risk for the stock in the next

6-12 months. Further, the management has guided for 24%-24.5% Ebit (earnings before interest and taxes) margins for FY15. This is lower than previously expected by the Street (25.5%). However, it is not a major worry, in our view. Low attrition, better client mining and reduction in onsite costs should provide upside to this guidance. Admittedly, all the three levers will work as growth trajectory improves. Overall, the stock may remain range-bound in the next six months, but we believe even an in-line performance in H1 will lead to a stock re-rating and upgrade in FY16 estimates.

Q4FY14 results overview

Infosys reported a revenue decline of 0.4% q-o-q in constant currency, led by volume growth of 0.4% and blended pricing decline of 0.8% sequentially in the IT services division. The margin expanded by 50bps despite weak growth in the quarter. The net profit growth of 25% y-o-y was boosted further by higher forex gains. Cash and investments for the company increased $5 billion. The company has increased the dividend payout ratio to 40% from 30% earlier.

Operating metrics in the quarter were a mixed bag: The cost optimisation measures continue to yield results as gross margins improved by 90bps. Fixed price contracts and utilisation (including trainees) in the quarter improved marginally on a sequential basis. Client mining has been weaker than expected as revenue per client declined for the ninth consecutive quarter. The top client declined 3% sequentially in the past two quarters. Also, the number of $100m+ and $200m+ customers declined in the quarter. Attrition is at the highest level in more than 24 quarters. As the companys focus on client mining improves in the near term, we expect improvement in growth recovery accompanied by better margins.

Macro remains positive: The companys management alluded to an improved deal pipeline compared to the last quarter, but decision cycles continue to remain long. Infosys won four large deals in the quarter with a total contract value of $700 million. Overall, we remain positive on the demand environment.

FY15 revenue growth outlook better than expectations: Infosys introduced the FY15 guidance of 7-9% growth, versus our and the consensus expectation of 6-8% growth. Consensus expectations have come down from 11-12% to 6-8% post the profit warning by the company on March 12. Infosys will have to achieve a CQGR of about 3% to reach its top end of the guidance. The management expects the FY15 operating margins to be about 24% owing to a low growth outlook, investments in sales, and the focus on large outsourcing deals. In the near term, we expect wage hikes and appreciating rupee to be the major headwinds.

Other key takeaways

n The company is gaining significant traction in products, platforms and digital technology. Infosys won 20 deals in cloud and 15 deals in mobility in the quarter. The company also won four new deals in product and three news deals in platform solutions.

n The company has announced a wage hike of 6-7% for offshore employees and 1-2% for onsite employees effective 1 April 2014.

n The company has revised its policy to increase the dividend payout ratio to up to 40% of post-tax profits (from 30% earlier).

n Infosys is hiring 200 fresh MBA graduates from major B-schools across to strengthen its sales team.

n The company has outstanding hedges of $1.06 billion.

Valuation and risks

Infosys is currently trading at 16x and 14x FY15/16e earnings. We revise our FY15/16 earnings estimates down by 8% and 9%, to factor in the rupee appreciation and a lower growth visibility. Subsequently, we reduce our target valuation to 17x (from 18x) and roll over to FY16 earnings (from 12 months ending September 2015 earnings). The companys growth is expected to be lower than TCS for the sixth consecutive year. The target valuation is based on a 20% discount to TCS, the Bellwether stock in the group, and factors in this underperformance. We revise our target price to R3,920 (from R4,100) and remain Overweight.

Downside risks: Currency appreciation, external candidate for the CEO position, delays in decision making and macroeconomic slowdown, etc.

Upside risks: A more aggressive go-to-market strategy and faster-than-expected conversion of deals.