The Indian IT service players are battling challenges — from drop in orders in the traditional services to stiff competition from big daddy tech companies in analytics and cloud.
But, as the market for digital services grows, clients will look for support from Indian IT service vendors with domain knowledge and proven execution capabilities.
Infosys’ digital acquisitions in recent years and its thrust on building its automation platform demonstrate its intent to capitalise on the digital space as the market opens up.
In the September quarter, the company’s revenue growth was the best in the last four years, thanks to a strong show in its largest market, North America.
In the US, though oil companies are in a muddle, the auto and auto ancillary companies are doing well thanks to a rebound in consumer spending. Also, discretionary spends continue in the digital space.
From a medium-to-long term perspective, Infosys seems a good pick among the large-cap IT players.
The correction in the last few weeks is a good opportunity to buy the stock.
Large deal wins, new digital ventures, higher revenue flows from existing clients and focused efforts to cut costs work in favour of the stock.
At ₹1,052, the stock discounts its estimated earnings for 2016-17 by 16 times. It has in the last three years traded in the valuation band of 13-20 times.
Firing on all cylindersIn the September quarter, Infosys recorded sequential dollar revenue growth of 6 per cent against analysts’ expectations of 3.6 per cent and TCS’ 3 per cent.
It added about 8,453 employees (net) — an all-time high, indicating that the company has good visibility in order flows. The total contract value of the new deal wins in the quarter was close to $1 billion — the highest ever for the company.
There were five large deal wins and 24 new (net) clients. Revenue from the top 25 clients grew a strong 7.9 per cent (in constant currency terms) showing that the company’s efforts to mine existing clients are yielding benefits. Strong growth in North America (6.1 per cent compared with 5.1 per cent in June quarter) and Europe (8.3 per cent as against 1.2 per cent), higher traction in financial services and retail segments, and improved pricing also helped. Also encouraging is that the growth has not come at the cost of margins.
Infosys’ margins expanded by 1.5 percentage points from the June quarter to 25.54 per cent in the September quarter, thanks to improved utilisation and operational efficiency. The utilisation rate stood at 81.3 per cent, up from 80.2 per cent in the June quarter. The second half of the year, however, may not be as good. The company indicated last week that due to seasonal factors and lower orders in the energy and retail segments, margins and performance may be a tad weak. Infosys has kept its revenue growth guidance (in constant currency) unchanged at 10-12 per cent for 2015-16 despite strong performance in the first half of the year.
However, the company is confident of achieving the industry average growth rate in 2016-17 as it focuses on client mining and getting new large orders.
The management’s efforts to arrest attrition (at 14.1 per cent in the recent September quarter, down from 21.1 per cent last year) and the broad-based growth in the last few quarters, with the total contract value of deals going up without compromising on pricing, bode well.
The three digital acquisitions — Panaya, Airviz and Kallidus this year — should also help the company gain market share as clients are cutting spends on ‘run the business’ services (business process outsourcing/application, development and maintenance) and spending more on digital. Also, as the company’s new automation platform starts to churn out more revenue, margins should improve.
Infosys is a better bet than TCS now. The latter’s growth has been faltering in recent quarters due to weakness in the insurance business (Diligenta) in the UK and poor traction in Japan and Latin American markets.
Better than TCS
The valuation gap between TCS and Infosys has narrowed sharply in recent times. On expected earnings of 2015-16, Infosys trades at a discount of 8 per cent to TCS (Infosys at 18 times and TCS at 19.6 times). At one point, it had traded at a discount of 13 per cent to TCS.
If Infosys’ stellar performance continues into 2016-17 and it shows growth across verticals and geographies, it may even see a valuation upgrade.