Margin beat a huge surprise; FY21/22e EPS up 4/3.7%; stock best long-term bet in sector; TP raised to Rs 1,295
Infosys reported a strong QF2Y21. Margin expansion of 270bps q-o-q to 25.3% was a bigger surprise than the modest revenue beat. Unexpectedly, the margin beat came from employee costs, which declined marginally q-o-q despite a 100% bonus and special incentive for employees. We continue to believe the sector will benefit from the tailwinds from spend on digital technologies, the transformation of legacy infrastructure and hence the need to migrate to the cloud.
Also, in our view, 50% of the global IT spend occurs in-house, which may move a bit to outsourcing post COVID-19. Infosys benefits from these industry tailwinds (including vendor consolidation) and market share gains. Infosys’s market share of incremental revenues has gone up to 24% (vs 18% of total revenues).
In the near term, we see a pause in the earnings upgrade cycle, not just for Infosys but for the sector. However, we think Infosys remains the best placed IT company to play the long-term compounding offering from the sector. In terms of margins, Q2 margins of 25.3% are likely to come down in H2 (22-24% guidance), led by wage inflation, hiring and reversal of some cost-cutting in H1 (travel, etc).
Q2 summary: Infosys beat street estimates with revenue growth of 4% cc q-o-q (vs Street expectation of 2.6%). Infosys also continued to outperform peers with y-o-y cc revenue growth of 2.2% in Q2 vs a decline of 3.2%/3.4% for TCS/Wipro. The company upgraded guidance for both revenue growth (2-3% vs 0-2% previously) and the Ebit margin (23-24% vs 21-23% before). Most key verticals have a strong outlook. A deal win of $3.15 bn in the quarter was its highest ever, with 16 large deals. Importantly, its share of new deals was 86%.
Retain Buy; lift TP to Rs 1,295 (from Rs 1,085): Key operating metrics were all strong and lend confidence to the near-term performance. Thus, we raise our EPS estimates by 4.0%/3.7% for FY21/22. While current valuations are above historical averages, the premium vs market is in line with historical trends, and we raise our target PE multiple for Infosys to 28x (from 25x), in line with our increase for the sector overall. This leads to a new TP of Rs 1,295 (from Rs 1,085); we retain our Buy rating.