Q2FY15slow and steady progress in operations: Infosys Q2FY15 revenues were $2,201m (+3.2% quarter-on-quarter, +6.5% year-on-year), marginally ahead of our estimates. Constant-currency growth was 3.9%, with 70 bps of cross-currency impact.
Growth was driven by seasonal improvement in spending and strength in some of the smaller verticals. Ebit margin expanded 100 bps to 26.1% despite a step-up in S&M (sales & marketing) investments.
Metrics that we follow to track progress turnaround was mixed but on improving trajectoryclient metrics improved moderately. Attrition is high but will decline after interventions. The company accelerated investments in S&M, a positive. Growth in IMS ((infrastructure management services) and BPO, which are growth drivers for the industry, could have been stronger.
Clarity on strategy expected by year-end: Sikka, in his first earnings call at the helm of Infosys, has laid out a broad vision for the Infosys of tomorrow. Key areas of focus will be(i) use of automation and artificial intelligence to improve efficiency in traditional services like BPO, IMS, testing, etc., (ii) developing a strong partner ecosystem with technology companies, including start-ups, to strengthen capabilities in emerging technologies, (iii) renewal of internal systems, policies and processes, and (iv) acquisitions to gain market access/capabilities. This, in our view, is just a high-level vision; details, financial and strategic, will be worked out over the next couple of quarters. With the right model as outlined, Infosys believes revenue growth of 15-18% and Ebit margin of 25-28% are possible.
Valuations favourable: Q2FY15 was a steady step forward. While specifics on strategy and execution are essential to take a definitive call on the turnaround, early signs are positive. Valuations are still on Infosys side. Despite the rally post results, the stock trades at <16X FY16e earnings. Increase in margin assumptions raise our FY15-16e EPS estimates by 1-2% and target price by 3% to R4,250 (R4,100 earlier). We value Infosys at 17xFY2016e earnings. Retain Add.
Strategy going forward: Some of the key themes highlighted by Sikka in his earnings call were
w Renewal of services through application of newer technologies. Infosys indicated that automation, artificial intelligence, machine learning, design thinking, etc. can be used to re-imagine the way services are delivered and to improve efficiency in traditional services like IMS, BPO and testing. This is an extension of the delivery excellence initiative driven by Narayana Murthy, but far more comprehensive in scope.
w Partner ecosystem. Infosys has already taken steps to strengthen its association with technology partners. It has expanded scope of working relationships with the likes of SAP, Oracle, and Microsoft and it continues to forge partnerships with technology companies. In the future, it will also need to engage with technology start-ups to strengthen its positioning in the emerging technologies.
w Skill development for workforce. Sikka indicated that with the changing technology landscape, employeesboth current and prospectivewill need to be trained/reskilled. Infosys is working on collaborations with leading technology universities to train its staff in areas like design thinking, artificial intelligence, etc.
w Inorganic growth strategy. Sikka indicated that Infosys will go for acquisitions that will help it acquire newer skills/technologies. He is averse to acquiring any company with similar skill sets, just for scale. The company is also open to acquisitions to gain entry to new markets or strengthen its position in select markets.
These are mainly high-level vision for taking the company forward. The company is confident that the outcome of these initiatives qualifies the company to be called a next-generation services company. Next generation services can grow 15-18% and have Ebit margin of 25-28%.
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