Buy Infosys - Moving towards Balanced Consulting and Business IT Services - Motilal Oswal

Visa issues concerning; near-bottom valuations provide comfort

- Seeking high quality, industry-leading growth by moving from a tech-heavy business model to Balanced Consulting and Business IT Services. We like the new strategy.

- Potential adverse impact of DHS' review of employer eligibility verifications on Form I-9 with respect to employees working in the US disconcerting.

- Valuations near bottom; discount to TCS at all-time high. Maintain Buy.

Moving away from tech-heavy business model

With much of the benefits of outsourcing realized, the industry getting rapidly commoditized and scalability issues mounting, Infosys' goal is to have an improved portfolio of businesses, ensuring high quality, industry-leading growth. Towards that end, the objective is to expand revenue from Consulting, Products and Platforms. However, it does not mean that it will lose focus on Business IT Services (BITS), which it considers essential to build deeper and sustainable client relationships, innovate processes, reduce costs, and have predictable revenues.

Restructuring efforts played their part on guidance miss

Infosys' 15.8% USD revenue growth in FY12 was lower than the 18-20% guidance the company gave at the beginning of the year. While the macroeconomic challenges were overwhelming, company-specific issues such as reorganization also impacted performance.

Impact of possible DHS action a concern

Excerpt from annual report: "The US Department of Homeland Security (DHS) is undertaking a review of our employer eligibility verifications on Form I-9 with respect to our employees working in the US. We have been advised that the DHS has found errors in a significant percentage of our Forms I-9 that the DHS has reviewed. In the event that DHS ultimately concludes that our Forms I-9 contained errors, the DHS would like to impose fines and penalties on us. In the event that the Government takes any actions which limit any Visa programs that we utilize, or impose sanctions, fines or penalties on us or our employees, this could materially and adversely affect our business and results of our operations".

Valuations near bottom; discount to TCS at all-time high

Infosys currently trades at 21% discount to TCS (1-year forward P/E), which is the highest ever. At 14.8x FY13E earnings, Infosys' multiple is near-bottom. Even from an FCF standpoint, Infosys' EV/FCF multiple in FY12 is 58% of TCS', the lowest ever in history. While two factors - [1] expected lower growth v/s TCS, and [2] large piled up cash reserves put to little use - may warrant some discount v/s TCS, discount at such steep levels should not sustain for long. We maintain Buy, with a target price of INR2,882 - 22% upside.

Source : Equity Bulls

Keywords