Infosys: IT’s a big deal

While the Indian IT sector is facing a challenging time at present, there are still a few good stock picks. Infosys, for instance, seems a value buy now.

The stock has been beaten down in the last few weeks on disappointment over its weak revenue guidance for 2016-17 at 8-9 per cent (down from its initial target of 11.5-13.5 per cent). It trades at ₹970 now, discounting its expected earnings for 2016-17 by 15.5 times — which is close to the lower end of its trading band over the last three years (15-19 times).

Infosys is taking steps to tide over the challenges, but these would take at least one more year to play out. Investors willing to wait can buy the stock now.

In the recent September quarter, Infosys did better than all its peers. The strong growth in most verticals and large deal wins of over $1 billion add to confidence. Though the second half of 2016-17 may not be good due to some client-specific issues, the long term looks bright.

The arguments in favour of the stock are its higher appetite for mergers and acquisitions (M&A) relative to peers, focus on innovative products and services (high value-high margin) — which opens up new business opportunities — and its effort to reduce costs that will prop up margins. TCS trades at premium to Infosys — at 18 times its expected earnings for 2016-17. Over the next one to two years, however, Infosys should do better than TCS, given its strategy of focussing on innovation-led digital solutions — a necessity in present times to counter falling spends on legacy services.

In the recent September quarter, Infosys recorded sequential revenue growth of 3.9 per cent in constant currency terms. The strong growth can be attributed to a good show across verticals.

The BFSI (banking, financial services and insurance) segment recorded growth of 5.2 per cent sequentially in constant currency terms, which the company said was helped by market share gains. The energy, utilities and communication vertical and the retail segment saw higher sequential growth relative to the June quarter.

The company’s European business revived with growth of 3.7 per cent (sequentially) from contraction of 0.3 per cent in the June quarter. The North America geography reported a 2.7 per cent growth versus 2.4 per cent in the previous quarter.

Infosys’ efforts to drive sales for the last few quarters appear to be paying off. The company won six large deals of total contract value of $1.2 billion ($809 million in the June quarter) — the highest in the last many quarters. Four of these deals were from existing clients and 60 per cent of the new orders were in the BFSI vertical.

Infosys is also working to revive the sagging consulting business, which it says will bear fruit in another two to four quarters. The company plans to make consulting a critical part of its engagement with all clients and is making the necessary investments. The company added 78 new clients during the September quarter with one new client in the $100-million-plus basket and two new clients in the $50-million basket.

Infosys’ operating profit margin expanded by about 80 basis points sequentially to 24.9 per cent in the September quarter on improved efficiencies, which offset the impact of downward pricing pressure. Employee utilisation was 82.5 per cent, up from 80.5 per cent in the June quarter and 81.3 per cent in the same quarter last year. The company saved 2,387 full-time employees (FTEs) worth of effort across service lines because of use of automation in the September quarter.

Though the company has guided for margin of 24-25 per cent in 2016-17 on lower revenue guidance, it may improve in the long term as its efforts to improve productivity pay up. The company now uses its artificial intelligence (AI) platform, Mana, in more projects which will help reduce costs by reducing the time and manpower required for solving problems.

Efforts to bring down the onsite effort mix (cost reduction through efficiently deploying people) and subcontractor expenses (through better supply-chain planning) will also help.

The company indicates that every 1 per cent decline in onsite mix can give a 50 basis point bump to operating margin. The onsite effort mix stood at 29.7 per cent in the September quarter, down from 29.9 per cent in the June quarter.

Infosys’ new platform and software services, which are priced relatively higher, may also help buttress margin improvement in the long term.

The policy uncertainty in the UK and Europe, post-Brexit, may see some delay in decision-making by companies in the region.

Also, any adverse changes to the immigration rules as such or to H-1B visas, in particular, in the US after the new President takes office, may have an impact on Indian IT companies. But this may be temporary as the industry will likely figure out a way to address it.