Infosys - Walking a tight rope and the chances of falling are high... - Asit C. Mehta

Infosys Ltd. (Infosys) declared its Q2FY13 numbers results, which were slightly below estimates on the top line and PAT front. The results were also lower than our expectations, even after getting a cushion from the Other Income front. In $ terms, the company reported 2.5% QoQ revenue growth at $1,797 mn, lower than our estimate of $1,806 mn and the street's expectations of $1,810 mn. In Rupee terms, the company reported revenues of Rs.98.5 bn, (a growth rate of 2.5% QoQ) against our estimate of Rs.99.1 bn. The operating margin took a hit of 166 bps during the quarter and was reported at 26.3%. This was due to higher subcontracting costs which have trebled over the past one year and certain provisions. We expected the operating margin to remain stable at 28%. The PAT at Rs.23.7 bn was in-line with our estimates.

KEY HIGHLIGHTS

- US$ revenue growth reported at sub 3%, which makes it difficult to the achieve 5% revenue growth target for FY13E. The asking rate has now climbed up to 3.7% from the earlier 3% for both the subsequent quarters, that too in a challenging business environment.

- The company managed to get a $25 mn benefit from hedging, which cushioned the PAT to the extent of Rs.3,750 mn.

- The company extended wage hikes to its offshore employees (6% wage hike) and onsite employees (2% wage hike). Offshore wage hikes will be effective from October 2012 and onsite wage hikes will be effective from January 2013.

- The company's 5% guidance does not include revenues from Lodestone, which are likely to be consolidated from the December 2012 quarter onwards.

-$ EPS for FY13E has been downgraded from $3.03 to $2.97, in order to adjust cross currency movements. While the Rupee EPS for the same year has been scaled down from Rs.167 to Rs.160, in order to factor the appreciation in the USD/INR rate from Rs.55/$ to Rs.53/$.

- Revenue growth rate has suffered during the quarter largely due to the India revenues, which declined 15% sequentially.

- The company added 39 new clients during the quarter out of which, 14 were from the BFSI space.

Sub 3% Dollar revenue growth will make it incrementally difficult to achieve the 5% revenue growth target for FY13E organically

- In a quarter that is supposed to be a traditionally strong period for IT companies, expectations were relatively low from an already struggling India's former IT bellwether - Infosys. The company has reported 2.5% revenue growth for Q2FY13, which is only slightly lower than our expectations. This puts additional performance pressure in the subsequent quarters. Infosys now will have to clock 3.7% growth for both the subsequent quarters in order to achieve the 5% revenue growth target for the year.

- Q3 is generally a weak quarter in terms of volumes due to fewer working days on account of holidays while Q4 is largely dependent on the budget flush, which might be absent considering the uncertain macro economic environment.

- In such a scenario, we believe that Infosys may struggle to achieve even 5% growth rate (organically), which is anyway far below the industry's growth rate standards for FY13E. The company also has no support from operating metrics. Although the company's consulting revenues grew 2.9% QoQ, there are no signs of improvement in pricing. The utilization level inched up during the quarter but, it is expected to fall as trainees join the billable workforce in the next two quarters. Attrition has stayed persistently high at 15%, which is higher than most of its larger peers.

- Excluding Lodestone, we expect Infosys' revenue to grow by 3.5% during FY13E. Including revenues from Lodestone, we estimate the revenue growth to be close to 5%. We downgrade our EPS estimates for FY13E and FY14E to Rs.160 and Rs.168 respectively from our previous estimates of Rs.166 and Rs.170 respectively.

VALUATION

The management commentary does not suggest a material improvement in the demand environment very soon. Operating metrics like relatively high attrition and persistent investments in the new strategy could exert further pressure on the operating margin. As of now, the road to recovery for Infosys seems to be a prolonged one. We believe that at present, taking a purely valuation call on Infosys seems like an imprudent strategy. At Rs.2,393, the stock is currently trading at 14.9x FY13E EPS of Rs.160 and 14.2x FY14E EPS of Rs.168. We continue to value Infosys at 14x the FY14E EPS, thereby arriving at a price target of Rs.2,357. We thus advice investors to REDUCE their exposure to this stock.

Source : Equity Bulls

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