Infosys - An asymmetric equation - Standard Chartered Securities

IN-LINE, INFO IN, CMP INR 2802, Price Target INR 2700

- The revenue growth versus margin equation stays skewed; flat 1QFY14 EBIT margin despite a strong volume growth + currency uplift.

- IER cautions on limited headroom in FY14 margin defence stays; but FY14 USD revenue growth could trend ahead of the 6-10% guided band, as deal momentum sustains.

- Minimal changes to IER's FY14/FY15 EPS forecasts; though consensus estimates could move up on INR reset.

- IER believes a material rerating could wait for consistency in quarterly performance; the 11% move post-results builds in an improved mid-range revenue trajectory; margin defence to be the key for incremental movement.

- IER stays In-Line; PT adjusted to INR 2,700 (vs. INR 2,600).

Revenue growth – Is the momentum back' 1QFY14 results surprised on strong volume growth (+4% qoq vs. IER 1.5% est.). Improved client metrics – active client base +5% qoq; positive movement across revenue buckets – and sustained deal wins (USD 1.6bn TCV over past three quarters); IER believes 6-10%FY14 USD revenue growth is conservative. IER FY14/FY15 forecasts are for 12%/13% USD revenue growth.

Margin defence is the key mid-term challenge. EBIT margin, ex-India business (+11ppt qoq), declined 54bp in 1QFY14. IER stays cautious on mid-range margin management given limited headroom. Impact of FY14 wage hike is higher (-300bp) given the reversal in the employee pyramid – share of 5-years+ exp. headcount at 52% in 1QFY14, the highest ever. Leverage from low utilisation is limited (26bp estimated sensitivity) + weak INR could help only partially after potential flow in pricing. Transition costs in outsourcing deals and increased onsite investments to mitigate US immigration reforms bill are other key headwinds.

Consistency is the key. IER believes sharp stock movements on the past 3 quarterly results reflect an excessive focus on q/q revenue growth + a proclivity to extrapolate (the quarter). The volatility may remain - 1QFY14 revenue surprise, like 3QFY13, came from higher growth in discretionary services that typically have short-term projects (and thus qoq revenue volatility).

Maintain In-Line. IER has adjusted FY14 USD revenue growth to 12% (from 10%). Its margin caution stays – as it builds 263bp EBIT margin decline in FY14 (with USD-INR at 57.9), though it could stabilise over FY15-16; FY14/FY15 EPS estimates are broadly unchanged. IER retains In-Line with a revised INR 2,700 PT (INR 2,600) on higher target multiple (14x vs. 13x) given lower risk from the proposed US immigration reforms bill. Reduced PER discount vs. TCS (11%) restricts upside.

Source : Equity Bulls

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