Infosys Ltd - Rating Revision - Centrum

Core svcs growth slow even considering offshore shift

We expect near-term margins to improve, but expect downward pressure in medium-term from aggressive pricing, renewed S&M investments and wage hikes. Though margin improved much ahead of expectations, we see some worrying signs with 62.3% of incremental rev. coming from Lodestone and vol growth of just 0.7% for IT Svcs incl. Consulting (excl. BPO and Finacle). We continue to believe that Infosys will lag peers in terms of revenue growth over FY15E, we think that the sharp de-rating we had worried about is not imminent given the margin improvement this qtr and upgrade to HOLD with a 1-Year TP of Rs3,490.

Offshore shift, headcount cut, S&M cost cuts, help push margins up: Margins were significantly ahead of our expectations with price realization improvement a pleasant surprise, we were surprised at the 1.1% decline in HC and S&M employee costs that have (at USD84.3Mn) gone back to absolute levels seen in 1QFY14 (USD83.8Mn). Near-term margins can expand further with utilization and fresher intake; large deal pursuits will involve increasing S&M spending as these typically involve bid spends of 1-1.5% of TCV (total contract value).

Lodestone-driven growth disappoints despite USD24Mn offshore shift drag: We note that even as Lodestone added USD21Mn even over 3QFY13, Consulting & Pkg implementation added only USD13Mn, suggesting a decline in existing run rate (though perhaps partly explained by offshore shift). Also disappointing was the USD11Mn decline in US run rate and only USD6Mn addition in Europe excl. Lodestone. It was disappointing to see vol growth at just 0.7% for IT Svcs & Consulting excl. BPO and Finacle (in 3QFY13 it had organic vol. growth of 1.5%).

Sales and employee pyramid broadening strategy tough to execute: Given the new focus on large deals, we had expected there will be some senior hires in the sales side as well as the technical workforce. But comments from the mgmt. suggest sales investments at the bottom of the sales pyramid and for technical workforce, the fresher heavy-hiring pattern continues. We think that skills needed to bid, structure and manage large IT Outsourcing deals are more of an art that take years of exp. and more lateral hiring will be needed than currently.

No de-rating worries for now: Given the sharp margin and pricing improvements, we increase our margin estimates for FY14E and FY15E even as we reduce rev. estimates marginally. We remain concerned about its ability to win large ITO deals and in new areas of discretionary spending and expect the P/E discount to TCS will widen given the growth differential. But with pricing and margin improvement, we think a sharp de-rating is not imminent and increase our target P/E to 14x (earlier 12x) and arrive at a new 1-Year TP of Rs3,480. Key upside risk is large wins, while downside risk is pressure on margins through billing rate declines or wage hikes.

Source : Equity Bulls

Keywords