Fundamental performance in Q3 was broadly in-line with 1% q-o-q revenue growth (CC), 20bps Ebit margin expansion and net-new deal intake normalising to a typical quarterly run rate of $580 mn from $280 mn in Q2.
In-line execution on financial metrics was a sideshow in Q3FY20 with real highlight being the clean chit given by the Audit Committee of the Board to the company and its executive leadership regarding the whistleblower allegations with there being no evidence of financial impropriety or executive misconduct. With the knowledge that SEC’s Office of the Whistleblower is running its own investigation, it is logical to presume that the investigation conducted by Shardul Amarchand Mangaldas and PwC would have been doubly thorough and as such carries a strong weight by itself.
Fundamental performance in Q3 was broadly in-line with 1% q-o-q revenue growth (CC), 20bps Ebit margin expansion and net-new deal intake normalising to a typical quarterly run rate of $580 mn from $280 mn in Q2. We tweak our FY21/22 revenue/EPS estimates modestly but maintain Buy with an unchanged target price of Rs 855.
Revenue growth broadly in-line; FY20 guidance raised modestly
Revenue increased by 1% q-o-q in both CC and USD terms with Eishtec business transfer contributing $3 mn to revenue in the quarter. Growth was impacted by higher than typical furloughs, especially in the banking vertical in Europe and RoW. Growth in CC terms on a y-o-y basis slowed in Q3FY20 relative to 12.4%/11.4% in Q1FY20/Q2FY20 respectively given a tougher compare but was still healthy at 9.5%. Digital revenues increased by 40.8% on a y-o-y basis. Revenue growth guidance for FY20 was raised from prior range of 9-10% in CC terms to 10-10.5% which would imply revenue growth in Q4FY20 in the range of 0-1.5% q-o-q in USD terms (I-Sec: 1.4%).
Margin execution also in-line; we see a modest upward bias over time
Ebit margin increased by 20bps q-o-q to 21.9% with gross margin being flattish q-o-q with G&A expenses as a percentage of revenues being down by 20bps q-o-q. INR depreciation adjusted for drag from revenue hedges helped margins by 10bps q-o-q with higher offshoring and better control on non-employee costs aiding margins by 50bps q-o-q. Lower utilisation and adverse changes in revenue productivity were a drag of 40bps q-o-q. Industrialisation of digital services, improvement in automation and productivity, selective rate revisions for digital services and continued focus on operational efficiencies should help margins improve from 21.6% in FY20 to 22.2%/22.5% in FY21/22.
Infosys stock price is still down ~10% since the whistleblower allegations came to light. With the overhang of the allegations alleviated and there being status quo on fundamental performance and outlook since Q2 results, we see no reason why the stock price should not go back to its prior highs. Maintain Buy with an unchanged target price of Rs 855 based on 19x Dec’21e EPS. At CMP, Infosys is trading at 17.5x FY21e EPS vs TCS being at 23.5x for broadly similar NTM revenue growth and modestly better headroom on margin improvement.