Infosys: Back in business (Hold) bl-premium-article-image

Vivek Ananth Updated - July 21, 2019 at 10:07 AM.

Big deals and digital growth have lifted the stock. But margin pressure could weigh on the stock

After some rough weather owing to a churn in the top management, Infosys appears to be finding favour with investors. The stock has rallied in the past few days and touched its 52-week high, drawing comfort from a good deal pipeline and revenue visibility.

The board’s approval of a new capital allocation policy that would return 85 per cent of cumulative free cash-flows to investors (against 70 per cent earlier) over five years has also cheered them.

The valuation gap between Infosys and TCS has narrowed after the June quarter results. Infosys trades at a 12-month trailing P/E multiple of 21.9 times compared to 24.3 times in the case of TCS. While healthy deal wins and robust growth in digital revenues augur well for the company, the stock appears fully valued after the recent rally.

Given that the upside is limited and salary hikes and a strengthening rupee could keep margins under pressure, investors can hold the stock and wait for a correction to accumulate for the long term.

Digital boost

Buoyed by its highest deal wins in a quarter, of $2.7 billion (in the quarter ended June 2019), the company raised its constant-currency revenue guidance for FY20 to 8.5-10 per cent from 7.5- 9.5 per cent.

The management attributed the revision to a decent deal pipeline.

The company has continued to see robust growth in digital revenues, which were 35.7 per cent of its revenues in the quarter to June. This helped the company report decent margins.

But the exuberance on the street could be short lived if some of the impact of higher employee costs deferred to the quarter ending September throws up surprises on the margin front.

The management maintained its 2019-20 operating margin guidance of 21-23 per cent.

But costs related to a ramp-up of new deals, higher compensation to new hires to stem the worrying attrition levels, and the salary hikes postponed to the September quarter for a set of employees, could add pressure to margins in the next quarter.

 

Mixed financials

Infosys’s net profit during the quarter to June 2019 fell 6.8 per cent quarter-on-quarter to ₹3,802 crore due to higher staff costs, depreciation and higher travel expenses.

Revenue came in at ₹21,803 crore compared to ₹21,539 crore in the quarter ended March 2019.

The revenue growth during the quarter was supported by growth in the communication and energy & utilities verticals. In terms of geographies, North America revenues have grown steadily for the past few quarters, while revenues from Europe are seeing slow growth due to a slowdown in manufacturing in the continent and the impact of some M&As in the financial services space.

However, the Stater acquisition from ABN-Amro helped Infosys grow its financial services business during the quarter. The segment (its largest) posted revenues ₹6,856 crore, up 0.75 per cent QoQ; in dollar terms, revenue rose 1.7 per cent.

Not without risks

Despite the higher revenue guidance for 2019-20, high levels of attrition could play spoilsport and dampen profitability.

The management says the attrition is not low among high-performing employees, and it is devising a strategy to curb attrition. Compared to TCS (11.5 per cent), Infosys’s attrition at 23.4 per cent is very high, and the company might have to spend higher amounts on staff costs to retain talent. This could impact margins if not checked.

The margin picture in the June quarter was somewhat sanguine as the company postponed some salary hikes for employees (excluding management) to the next quarter.

This could dampen the margins for the July-September quarter.

There is also the risk that ongoing global trade wars could impact trade and lead to some clients curtailing spends.

This could impact revenue growth for Infosys, and could in turn mean a lower utilisation of staff that the company has hired in the US and Europe to increase localisation of talent.

Over the past 12 months, the rupee has steadily strengthened, which could dampen profitability.

Published on July 20, 2019 13:47