Infosys Limited - Good quarter... but revenue volatility to stay - Antique

Infosys 1Q USD revenues grew by 2.7% QoQ, 1.4% ahead of our estimates. However high contribution of consulting revenues to growth as witnessed during 3Q FY13 leads us to believe that revenue growth is likely to be volatile in coming quarters. Also realization vs. 3Q declined QoQ for both onsite & offshore and management commentary on pricing pressure for rebid deals (high contribution to deal pipeline) indicates that EBIT margin likely to remain under pressure despite a depreciating rupee. While utilization at 73% has scope to improve, it is already up 500bps YoY. Key positive though were strong pick up in application development and healthy deal wins during the quarter.

While we cut our margin assumptions by ~100bps for both FY14E and FY15E to factor wage hike impact, partly offset by rupee depreciation, we raise earnings by 2-3%. See upside of 11% under best case scenario. Retain HOLD with revised target price of INR2700. We would watch out for 2Q margins before changing our view on the stock.

Good 1Q... though risk of volatility remains

1Q revenues grew by 2.7% QoQ led by 3.4% QoQ growth in volume and 0.7% QoQ decline in price realization. While quarter performance was strong we note that growth was driven by consulting/ SI -discretionary (6% QoQ), application development (up 4% QoQ) and testing (4% QoQ). Discretionary spends yet to pick up and hence risk of revenue volatility remains. All verticals excluding telecom grew during the quarter. Infosys added 66 new clients and seven large deals worth USD600nm during the quarter. Management has retained its full year revenue guidance of 6-10% YoY for FY14E.

Margins tad lower than expected... likely to be under pressure

EBIT margins improved by 9bps to 23.6% QoQ. Gains from rupee depreciation was fully offset by impact from wage hike for onsite, higher visa cost and salary hikes for sales. We expect margins to be under pressure given 1) wage hikes for offshore/ onsite effective 2Q, 3) increasing pricing pressure for rebid deals and increasing contribution of onsite revenues. While utilization (including trainees) at 73% remains low, we note that utilization is already up 500bps YoY. PAT declined 0.9% QoQ to INR23.7bn, 0.6% lower than our estimates.

Valuations... 10% upside in best case

While we cut our margin assumption to factor impact of wage hikes, we raise our earnings estimates by 2-3% for FY14E and FY15E. Post 1Q stock appreciation, we believe upside likely limited from current levels. Even best case-assuming USD/INR of 59 and margins to improve (vs. decline assumed now) we think stock could potentially deliver upside of 11%. We would watch out for 2Q margin performance and wait for pullback on the stock before changing our view on the stock.

Source : Equity Bulls

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