Infosys - Fool me once... - Ambit

Infosys's share price declined by 22% on Friday, closing at Rs. 2,297, a tad above our target price of Rs. 2,280. We have been sellers of Infosys and have consistently highlighted the continued weakness in the demand environment, particularly in discretionary services, and challenges in Infosys's competitive positioning, given its late entry into Infrastructure-led services. Although our stance on Infosys was among the most pessimistic in the market, the weak 4QFY13 results (organic revenue up 0.8% QoQ and EBIT margins down 213bps QoQ) and disappointing FY14 revenue growth guidance (6-10% vs our expectation of at least 12%) took us by surprise as well. We cut our FY14 USD revenue growth estimate to 8.7% (from 11.6% earlier) and remain SELLers, with a target price of Rs. 2,138.

Disappointing 4QFY13 results: Infosys reported weak quarterly numbers with 4QFY13 revenues of US$1938mn (up 1.4% QoQ and 0.8% QoQ organically). EBIT margins declined to 23.6%, 186bps below our estimates. EPS was ahead of our estimates and in line with consensus estimates, owing to higher other income and lower taxes. The key sources of underperformance were the Energy and Retail verticals, Consulting & System Integration and the Rest of the World business, suggesting that the strengths seen in 3QFY13 were a flash in the pan.

Uninspiring FY14 guidance: Infosys guided to 6-10% YoY FY14 USD revenue growth, 400bps lower than our conservative estimate, at the mid point of the guidance. The management abandoned earnings guidance, indicating potential margin uncertainties from volatile revenue productivity, onsite costs and wage increases. It indicated a potential change in compensation towards higher fixed salaries. This may have a short-term negative margin impact and it remained silent on the annual wage revision cycle. Voluntary attrition increased by 60bps QoQ in 4QFY13 and could potentially aggravate further, with a lack of clarity on FY14 salary revisions.

Our base case holds: We had highlighted three scenarios in our note "Can the elephant dance?" dated 20 September 2012. We hold our base case of Infosys pursuing the currently articulated strategy but achieving limited success and struggling with verticalised delivery. We had envisioned industry leading margins for Infosys in this scenario, which no longer holds true. We lower our EBIT margin estimates by 126bps and 70bps for FY14 and FY15, respectively. The results and the guidance indicate that the market's expectation of Infosys winning back market share (through incremental aggression) whilst its low utilisation help the firm maintain margins, were optimistic. Despite Infosys now trading at 13.9x FY14 EPS, we do not see this as an attractive entry point. Higher volatility over the past few quarters will remain an overhang on the multiples. We remain SELLers with a TP of Rs. 2,138, implying 13.1x FY P/E.

Source : Equity Bulls

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