By Angel Broking
Performance backed by healthy volume growth: Infosys’s consolidatedtop-line for 1QFY2011 was in line with our estimates. In rupee terms, top-line grew 4.3% qoq to Rs6,198cr, while in US dollar terms, the growth was 4.8% qoq to US $1358mn. The growth was backed by volumes, which were up 7.6% qoq, while the blended pricing was lower by 1.6% qoq. However, on account of the annual wage hike, EBIT margins fell by 178bp qoq to 28.3%, while the PAT declined by 7.0% qoq to Rs1,488cr on account of higher tax rate.
FY2011E guidance revised upwards: Infosys has revised its FY2011E revenue growth guidance from the earlier 16-18% to 19-21% yoy, and EPS growth from the earlier 9-4.3% to 5-10% yoy in US dollar terms. In rupee terms also, the revenue growth guidance has been revised upwards from the earlier 9-11% to 16-18% yoy, and EPS growth guidance from the earlier (2.6%)-1.4% to 7.2-11.5% yoy.
Outlook and Valuation: We expect Infosys to register CAGR of 19% in top-line over FY2010-12E backed by 17% CAGR in volumes. However, EPS is likely to register subdued CAGR of 12.6% during the period on account of lower EBIT margins and increased tax rate. The stock is currently trading at 23.2x FY2011E EPS of Rs118 and 19.9x FY2012E EPS of Rs138. Though adverse macro economic factors like the Europe crisis and cross-currency movements are cause for concern for the IT companies, we believe growth will be sustained through volumes with pricing remaining stable. Thus, we have valued the stock at 21x FY2012E earnings, which is at ~25% premium to Sensex PE of 17x FY2012E earnings (Infosys has traded at an average premium of ~25% to the Sensex PE during FY2005-10) and maintain our Accumulate rating on the stock, with a Target Price of Rs2,900.
Broad-based growth across services and verticals driven by volumes
Infosys recorded a 4.3% qoq (13.3% yoy) growth in top-line for 1QFY2011 backed by the 7.6% qoq growth in volumes, despite a 1.6% qoq dip in blended pricing and negative impact of 0.7% qoq appreciation in the rupee vis-ŕ-vis the US dollar. The adverse cross-currency movement also restrained further growth in top-line as the rupee continued to appreciate even against the euro and GBP by 8.6% and 5.1% respectively, during the quarter.
The growth was led by a strong sequential growth of 21.7%, 15.3% and 7.4% in Product Engineering services (PES), Testing and ADM (application development and maintenance) services, respectively. Verticals-wise, Infosys witnessed strong growth of 8.2% in BFSI led by the 13.8% growth recorded in the Insurance domain, while the Energy & Utilities and Retail verticals grew by 7.9% and 5.9%, respectively.
Geography-wise, strong growth was delivered by North America, India and Rest of World, which grew by 6.2%, 26.6% and 11.6% respectively, on a qoq basis. However, the 5.9% qoq decline in revenues from Europe on account of the ongoing crisis restrained growth.
The company added 38 new clients during the quarter, of which 6 were from banking product Finacle, taking the total active clients to 590. The company added two US $100mn clients in 1QFY2011. The company also closed couple of large deals during the quarter whereas few transformational deals are in the pipeline. The Top-10 and -25 client accounts witnessed qoq growth of 6.6% and 5.2% respectively, while repeat business contributed 99.4% of the revenues compared to 95.4% in 4QFY2010.
Sustained rupee appreciation across currencies, salary hikes impact margins
During 1QFY2011, Infosys recorded a 178bp qoq (173bp yoy) contraction inEBIT margin, of which ~ 300bp impact came from negative impact of cross-currency movement and annual salary hikes effective during the quarter. However, the 160bp qoq increase in utilisation to 78.7% excluding trainees (utilisation including trainees was up by 370bp at 73%) during the quarter had a positive impact of ~100bp on the margins.
In terms of operational costs, the negative impact on margins was on account of the 140bp increase in employee costs, as the company incurred US $12mn on visa costs during the quarter in addition to the salary hikes, while the General & Administration expenses also went up by 50bp qoq.
Lower operational profitability, higher tax restrains bottom-line growth
Infosys reported 5.2% qoq (11.2% yoy) decline in other income mainly on account of the forex loss of Rs81cr v/s gain of Rs97cr in 1QFY10. The tax rate during the quarter also went up from 21.6% in 4QFY2010 to 25.4% in 1QFY2011 as ~80% of profits (compared to 70% taxable earlier) would come under taxable income as the tax benefits availed earlier now phase out. Thus, lower operational profitability and other income coupled with higher tax outgo impacted bottom-line, which fell by 7% qoq (2.4% yoy).
Gross addition of 8,859 employees; High attrition
Infosys added a gross of 8,859 employees in 1QFY2011, while net additions were 1,026 (vis-ŕ-vis 3,914 employees in 4QFY2010). The company has 114,822 employees on its rolls as of 1QFY2011, and has revised upwards its gross addition guidance from earlier 30,000 to 36,000 employees as on 1QFY11 expecting strong volume growth in FY2011E. The attrition rate however stood high at 15.8% in 1QFY2011 on account of the overall buoyancy in the job market with a strong economic recovery.
Strong 2QFY2011E guidance
Although the company registered a subdued performance for 1QFY2011, it has given a strong revenue growth guidance of 6-7% for 2QFY2011E, in rupee terms backed by growth in volumes. The company also plans to make gross employee addition of 14,000 in 2QF20Y11E. Margins are expected to improve compared to 1QFY2011 as there will be no impact of the annual wage hike, which has already happened in 1QFY2011. The company has guided for 5-7% qoq growth in EPS.
FY2011E guidance revised upwards
Infosys has revised upwards FY2011E revenue growth guidance in US dollar terms ranging between 19 - 21% yoy, and EPS growth to range between 5.2 - 9.6% yoy. In rupee terms, the revenue guidance ranges between Rs26,441 - 26,885cr, a yoy growth of 16.3 - 18.2%, and EPS ranges between Rs112.2 - 116.7, implying yoy growth of 7.2 -11.5%.
The company’s strong upward guidance is based on the robust client feedback with improvement in the demand environment and infusion of 36,000 gross employees to deliver strong volume-backed growth with pricing expected to remain stable.
Investment Arguments
Strong growth in US and emerging geographies to combat Europe crisis:
Though Europe continues to be a spoilt sport for the Indian IT industry till the concerns wear out, some of the other levers for the company’s growth are the recovery in the IT spend from the US and emerging geographies. Thecompany also expects to get increasing wallet share from its existing clients and is witnessing improvement in IT spends more on offshore. Moreover to combat the European concerns the company plans to proactively increase investments in creating capabilities and hence plans for strong manpower intake in FY2011. We expect growth to remain broad-based with key verticals like BFSI, energy and utilities and high-margin services like consulting and package implementation are expected to do well.
Strong volume led growth with stable pricing to maintain profitability Though the cross-currency movement remains a concern, we expect the company’s short-term hedging policy to arrest its impact on operational profitability to a large extent. However, the increasing attrition rate is a cause for concern. Hence, we expect employee cost to move up going forward to retain the best of the talents, as the job opportunities are coming back with buoyancy in the overall economy. However, on the back of strong volume-backed growth and stable pricing, we believe that the company will maintain the EBIT margins albeit in a narrow band going forward.
Outlook and Valuation
We expect Infosys to register CAGR of 19% in top-line over FY2010-12E backed by 17% CAGR in volumes. However, EPS is likely to register subdued CAGR of 12.6% during the period on account of lower EBIT margins and increased tax rate. The stock is currently trading at 23.7x FY2011E EPS of Rs118 and 20x FY2012E EPS of Rs138. Though adverse macro economic factors like the Europe crisis and cross-currency movements are cause for concern for the IT companies, we believe growth will be sustained through volumes with pricing remaining stable. Thus, we have valued the stock at 21xFY2012E earnings, which is at ~25% premium to Sensex PE of 17x FY2012E earnings (Infosys has traded at an average premium of ~25% to the Sensex PE during FY2005-10) and maintain our Accumulate rating on the stock, with a Target Price of Rs2,900.
In line with the upward revision in Infosys’s guidance for FY2011E and expected higher infusion of gross manpower, we have also upgraded our FY2011E and FY2012E top-line estimates. We however, expect other income to be lower on account of the expected unfavourable cross-currency movement. We estimate PAT to be slightly higher in FY2011E compared to our earlier estimates, as volume growth would take care of lower margins. However, PAT in FY2012E would be slightly lower than our earlier estimates, as margins are expected to dip with the rise in employee costs to arrest higher attrition.
