We find Q2 FY18 results to present a mixed bag for investors. We find (i) the board deciding to put to rest past allegations of Panaya deal and (ii) strong execution in Q2 FY18 to be positive (11% and 6% beat at PAT level to our and consensus estimates, respectively), while the guidance cut in constant currency revenue growth in FY18e to be negative. We marginally raise our FY18e EPS by 2.2% and leave our TP based on 16x FY19e EPS (same as TCS) unchanged. Maintain Outperform.
Hunt for CEO continues, strategy under new chairman seems to be largely unchanged: The outcome of its strategy refresh under Nilekani’s chairmanship underscores Infosys’ focus on the digital (software + services) strategy to remain relevant to its client base. The hunt for a new CEO continues amongst a pool of internal and external candidates and the alumni club. We think that the board finding no wrongdoing in the Panaya acquisition and deciding to close the matter is comforting as it will aid senior management to avoid further distractions. Infosys is fast filling the vacancies in digital/software leadership roles with both internal and external candidates.
Q2 FY18 results—strong execution steals the show: We were impressed with the Ebit margin at 24.2% (+10bps q-o-q, -70bps y-o-y) despite the headwinds of wage hikes. Gains from higher utilisation and lower onsite efforts (totalling 80bps) were used to fund the wage hikes. Revenues at $2.7 bn (+2.9% q-o-q, +5.5% y-o-y in reported terms, +2.2% q-o-q in constant currency) came in as expected.
Is there too much to worry about a guidance cut? Infosys has lowered its guidance for FY18E revenue growth to 5.5-6.5% from 6.5-8.5% (in constant currency) and 6.5-7.5% y-o-y from 7.1-9.1% y-o-y (in reported terms) citing anticipated weakness in H2 FY18. We think this is partly linked to the absence of expected tailwinds in BFSI, which management had anticipated at the start of FY18 (similar to TCS). We note that despite lowering our FY18E $ revenue growth estimate from 7.2% to 6.7% now, we have raised our EPS by 2.2%. We expect the FY18E Ebit margin to be at the mid-way of 23-25% guidance.
Earnings and target price revision—+2.2% in FY18E EPS, <1% change in FY19-20E EPS. No change in TP.
Price catalyst —12-month price target: `1,070.00 based on a PER methodology. Catalyst: finalisation of CEO, pick-up in large deal wins.
Action and recommendation — We think that the 25% valuation gap between Infosys (13.9x FY19E EPS) and TCS (17.4x FY19E EPS) is high given similar expected growth rates in $ revenues (8% y-o-y) in FY19E. We think that the gap will narrow once clarity on the new CEO emerges over the next few months. Our preference order in large cap Indian IT pack remains HCL Tech > Infosys > TCS > Wipro and Tech Mahindra.