Infosys - A Case Of Great Expectations - Nirmal Bang

Infosys' stock has rallied nearly 25% over the past two-odd months following betterthan-expected 3QFY13 results. In our view, such a steep upward move implies great expectations of the street regarding an improved performance in FY14. While we expect Infosys to increase its revenue at a faster rate in FY14, we believe it will come at the cost of margins, given the need to show flexibility in pricing and deal structuring; 3QFY13 EBIT margin was at a 22-quarter low and we have factored in 113bps YoY EBIT margin decline in FY14E. We expect this to impede earnings growth and have factored in 7.6% EPS CAGR over FY13E-FY15E; the current valuation of 14.9x FY15E EPS is not cheap and under-performance against high expectations could trigger a correction. We have retained Sell rating on Infosys with a revised TP of Rs2,685 (Rs2,310 earlier), rolling over our valuation multiple to FY15.

Stock surge implies great expectations, revenue growth seen at the cost of margins: Infosys' stock has surged nearly 25% over the past two-odd months following better-thanexpected 3QFY13 results. In our view, such a steep move implies great expectations of an improved performance in FY14. While we expect Infosys to grow its revenue faster in FY14, it will be at the cost of margins because of a highly competitive market and the need to show flexibility in pricing and deal structuring (read make upfront investments).

Margins to remain under pressure; 3Q EBIT margin at a 22-quarter low: As we have stated above, while we expect FY14E revenue growth to be better than FY13E (13.6% versus 6.5%), we believe it will come at the cost of margins, given the need to be more flexible on pricing and deal structuring. We believe it is a trade-off, an 'either-or' situation as regards revenue growth and margins, and in the wake of revenue market share loss over the past many quarters (refer Exhibits 1 and 2), we expect Infosys to opt for the former. It should be noted that while 3QFY13 revenue growth was impressive, EBIT margin was at its lowest level since 1QFY08 (22 quarters). We expect 113bps fall in FY14E EBIT margin (25.1% versus 26.3% in FY13E), led mainly by higher employee costs.

Financial services budgets likely to shrink in CY13/FY14: Infosys sees IT budgets in the key financial services vertical shrinking in CY13/FY14 owing to muted growth prospects of its clients across all major segments - banking, capital markets and insurance. Greater focus is likely on run-the-business initiatives for cost savings. In our view, this could lead to some pricing pressure in this vertical. Given that financial services contributed 33.7% to 3QFY13 revenue, by far Infosys' largest vertical, this could prove to be a headwind for FY14 revenue growth.

Margin pressure to lead to tepid EPS CAGR of 7.6% over FY13E-FY15E, retain Sell: While we expect higher revenue growth in FY14 for Infosys compared with FY13, we expect the pressure on margins to lead to a tepid EPS CAGR of just 7.6% over FY13EFY15E. The stock currently trades at 14.9x FY15E EPS, which in our view is not cheap in the light of slow EPS growth expected by us. We believe the possibility of disappointment on high expectations could trigger a stock price correction. We have retained our Sell rating on the stock with a revised target price of Rs2,685 (Rs2,310 earlier), rolling over our valuation multiple to FY15.

Source : Equity Bulls

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