Infosys Ltd - Q3FY14 Result Update - IIFL

Revenue growth was sluggish than expected; volume growth was muted at 0.7% qoq

Infosys' reported Q3 FY14 dollar revenue growth performance was weaker than expected. Constant currency (CC) growth of 1.2% qoq came in lower than our estimate of 2.1%. There was a material improvement in CC pricing both onsite and offshore by 1.8% qoq and 1.7% qoq respectively. However, the blended pricing improved only by 0.2% qoq due to 130bps effort mix shift towards offshore. Against our volume growth expectation of 2% qoq, company delivered a rather muted 0.7% qoq growth materially impacted by furloughs and holidays in the quarter. Cross currency movements aided dollar revenue growth by 50bps due to dollar depreciation against other business currencies.

FY14 dollar revenue growth guidance raised to 11.5-12%, in-line with expectations

Implying modest growth of (0.3)-1.4% qoq in the current quarter, Infosys revised its annual dollar revenue growth guidance to 11.5%-12% from 9-10%. The guidance raise along with improved business commentary distinctly suggests an upgrade in sentiment and growth expectation at Infosys. We expect the company to surpass its guidance.

Growth remains disparate within verticals, geographies and services; client mining continues

During Q3 FY14, while revenues from manufacturing de-grew marginally, BFSI and RCL (Retail, Logistics, CPG and Life Sciences) verticals witnessed better-than-company CC revenue growth of 1.5% qoq and 2.9% qoq respectively. Regionally, growth was driven by non-US geographies with revenues from Europe, RoW and India registering strong CC growth of 3.5%, 5% and 8.1% qoq respectively. Within service offerings, growth was impressive in Testing (5% qoq), BPO (3.3% qoq) and Products (4.4%) while maintenance and PI/consulting grew slightly ahead of overall revenues. Client mining initiatives of Infosys continues to manifest in brisk revenue growth (3% qoq) from non-Top 10 clients and increasing number of clients in sub-US$50mn buckets.

OPM expansion was ahead of expectation; aided by offshore shift and efficiency gains

Infosys' OPM performance was strong with improvement of 170bps qoq, much better than our expectation of 100bps. In spite of marginal dip in utilization (from 73.1% to 72.5%), company's gross margin improved by 100bps qoq supported by offshore effort shift, material pricing improvement and various efficiency initiatives taken. The 90bps qoq decline in sales & marketing cost as a percentage of sales also contributed significantly towards OPM expansion. At 4.9%, the S&M cost stood at a multi-quarter low. The employee count declined by 1,362 (1.1% on Q2 FY14 base) in IT Services & Consulting and by 350 (1.3% on Q2 FY14 base) in BPO business. Incremental volume growth is likely to drive an uptick in utilization (at 72.5% is much lower than peers) thereby benefiting margin. We estimate Infosys operating margin to expand by minimum 100bps in FY15 and FY16.

Estimate strong earnings growth; Retain BUY and upgrade 9-12 month TP to Rs4,132

Infosys Q3 FY14 performance was impressive with margin responding handsomely to efficiency/cost savings underway. An improve revenue growth environment would provide further fillip to margin expansion and therefore to earnings growth. We estimate earnings CAGR of 16-17% for Infosys over FY13-16 and expect valuation to re-rate to 16x 1-year fwd earnings implying a PEG ratio of 1x. Our 9-12 month price target is Rs4,132 implying an upside of 16.5% from current levels, thus retain BUY.

Source : Equity Bulls

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