Infosys: On the right path

Under its new management team, Infosys exhibited predictability in revenue growth and operational performance for the second quarter running. While we believe revenue growth revival will be gradual, we are enthused by: (i) strategic clarity around re-inventing its core offerings and using innovation to drive traction in newer technologies;(ii) likely better cash utilisation/return after Q4. Given our positive stance on sector demand and comfort on the management, we retain our Buy and TP (target price) of R2,220.

Catalysts—improvement in deal wins; in-line Q3: Q3 results were in line on constant currency (CC) revenue growth at 2.6% quarter-on-quarter (vs our estimate of 2.8% q-o-q) and Ebit margins (which ex of provision reversals) were flattish. Volume growth of 4% q-o-q in a seasonally weaker quarter, CC growth and positive outlook in BFSI (one-third of revenues) and improvement in year-on-year growth trajectory in the US were the key positives. Key disappointments included CC pricing decline of 170bps q-o-q and muted deal wins of $213m (vs $500-700m over the prior six quarters).

INR depreciation to offset cross currency impact: Our constant currency USD revenue growth expectations and EPS (earnings per share) estimates are largely unchanged after the results. We reset our currency assumptions to USD-INR rate of 62.5 (vs 61 earlier) and build cross currency impacts in Q4FY15F (forecast) of 100 basis points. We look for USD revenue CAGR of 12%, stable Ebit margins at 26% and EPS CAGR of 11% over FY15-17F. Our TP is based on 17x one-year forward EPS up to Dec-16 of R130.7.

Steady performance again: Infosys posted a steady 2.6% q-o-q growth in Q3 in CC terms (after a 3.9% q-o-q growth in Q2), while keeping a tight control on operations, leading to margins sustaining at the 26% Ebit (earnings before interest and taxes) levels. Key positives of the results include:

Improvement in y-o-y growth trajectory in the US to 8% y-o-y (after decelerating for the last four quarters to 5% levels in Q2).

Strong growth in BFSI (banking, financial services and insurance) at 4% q-o-q in CC terms and positive outlook on demand.

Best volume growth in three years at 4.2% q-o-q (especially in a seasonally weak quarter).

Strong operational performance with 150bp q-o-q increase in fixed price proportion to 42.9% and utilisation excluding trainees improving to 82.7% (highest in last 11 years)—with management indicating scope for a further 100bp+ expansion.

Revenue revival could be gradual: We retain our view of 12% USD revenue CAGR (compound annual growth rate) in CC terms over FY15-17F (an improvement vs ~7% CC growth in FY15F) and believe while directionally the company is moving on the right direction, the challenges associated with on-the ground execution of management’s strategy temper our exuberance. The key being:

Weak large deal traction: Q3 large deal wins TCV (total contract value) at $213m was the lowest in last seven quarters. The company has been in the quarterly deal TCV signings range of $500-700m for the prior six quarters.

Portfolio issues: Such as smaller contribution from faster-growing services like IMS(infra management services)/BPO (13% of revenues vs 24-39% of revenues by peers) and likely drags from a higher on-premise share of enterprise solutions business. This may lead to Infosys growing slower in consulting and system integration.

Pricing declines: Despite the 4% volume growth, what keeps us cautious is the decline in constant currency pricing in three out of the past four quarters.

We will monitor for improvements in these parameters before we turn constructive on growth.