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Infosys Rating: Add | Renewed focus on cost efficiency

Infy reported 20.8% margin in H1FY23, guidance implies margin is likely to remain stable at 21.5% for the next two seasonally weak quarters.

Infosys Rating: Add | Renewed focus on cost efficiency
Growth continued to be strong in digital, which grew 31% y-o-y CC. Cloud revenue crossed $1bn for the quarter.

Infosys (Infy) has retained its revenue growth leadership among tier-1 IT companies with healthy revenue growth of 4% q-o-q CC (constant currency) in Q2FY23, but it was below our/consensus estimates of 5%/4.5%. Growth continued to be strong in digital, which grew 31% y-o-y CC. Cloud revenue crossed $1bn for the quarter.

Signs of cautious behaviour amongst clients are visible in terms of delay in decision making in select verticals. Management pointed to emerging weakness in telecom and Hi-tech verticals especially in discretionary spends apart from retail and mortgage subsegment in BFSI called out in previous quarter. Despite macro headwinds leading to weakness in certain pockets, Infy won an impressive broad-based large deal TCV (total contract value) of $2.744bn, up 27.5% y-o-y, highest in last seven quarters. TCV comprises healthy 54% net new deals. Management alluded to increased traction in cost efficiency and automation deals. This is also reflected in an uptick in core services revenue in Q2FY23. Higher scrutiny on spends is resulting in renewed focus on cost takeouts. Management revised the lower end of revenue guidance band upwards to 15-16% y-o-y CC vs 14-16% earlier driven by strong performance in H1FY23 and strong bookings. Guidance factors in slowing demand in certain verticals and seasonal weakness historically experienced by Infy in H2 mainly due to furloughs and lower working days.

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Infy reported impressive improvement in Ebit margin of 150bps q-o-q to 21.5%. Margins benefitted from tailwinds of (i) 70bps from currency benefit, (ii) 90bps from cost optimisation, (iii) 40bps from reducing sub-con costs. These tailwinds were partially offset by 40bps impact due to compensation-related headwinds rolled out on July 1, 2022 for senior and mid-level employees.

Management lowered Ebit margin guidance to 21-22%, in line with the earlier stated commentary of margins expected to be near the lower end of guidance. Infy reported 20.8% margin in H1FY23, guidance implies margin is likely to remain stable at 21.5% for the next two seasonally weak quarters.

Our EPS estimates increase by 1.3%/1.8% for FY23/24 largely led by an increase in US$/INR rate assumption. We note that pain due to macro headwinds is evident in the sector and our revenue estimates already bake in a possible recessionary scenario. However, we upgrade Infosys to Add (earlier: Hold) because we believe (i) Infosys will benefit from cost-takeout deals, (ii) it is likely to deliver industry-leading growth, (iii) its margins have bottomed out and will likely improve hereon and (iv) favourable valuations of 21x on FY24e EPS (only 12% premium to 10-year average 1-year forward earnings multiple). We value Infy on 23x FY24e EPS to arrive at a target price of Rs 1,564 (prior: Rs 1,470).

Other key highlights
Revenue growth was led by manufacturing, LifeSciences, HiTech and Financial Services.
In retail vertical, demand is healthy for digital consumer engagement services and legacy modernisation. But Infosys is witnessing slow-down in fashion and discretionary retail.
Infosys won 27 large deals with total TCV of $2.744bn, 27.5% y-o-y. Large deal pipeline is strong with good mix of transformation and cost optimisation deals. Focus on cost optimisation by clients has increased demand for cost efficiency .

Infosys announced open market share buyback of Rs 93bn at a price not exceeding Rs 1,850 per share. Buyback size is in-line with the company’s policy to return 85% of FCF over five years.

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First published on: 17-10-2022 at 02:45:00 am