Can Infosys Maintain Its Growth Rate?

 |  Includes: ACN, CSC, CTSH, HP, IBM, INFY
by: G. Subra

FYQ2’10 Earnings call summary

Infosys (NASDAQ:INFY) reported a FYQ2’10 revenue of $1.154B, with EPS of $0.56, flat YoY and better than company guidance of $0.51. Revenues increases by 2.8% QoQ but declined 5% YoY. Constant currency revenue growth rate QoQ was 1.2%. INFY reported operating margin of 30.3%, 20bp better than Q1’09.

FYQ3’10/ FY2010 Guidance

INFY guided to revenue of $1.155 to $1.165, flat to 1% increase QoQ and below consensus estimate of $1.17B. EPS was guided to $0.50, 10% decrease QoQ and below consensus estimate of $0.51. FY10 revenues were guided to $4.60 to $4.62, slightly below the consensus estimate of $4.65B. FY10 EPS guidance of $2.09-$2.10 was below the consensus estimate of $2.14.

Investment thesis

Price stability

Infosys sees relative price stability across their verticals thanks to fixed priced contracts. Per their AVP of high tech sales in US, 40% of their projects currently use fixed prices contracts, and the future is trending to be that way, given that the customers are beginning to understand what they need and Infosys is continuously developing the domain knowledge required to implement the solution in a shorter frame of time.

Demand improvement seen

Infosys continues to see new deals coming through at a better rate compared to FYQ2’10. While more customers are beginning to realize the why and what they need to offshore, we will continue to see a growth in the outsourcing industry. Calender year 2010 budget will probably be flat to low single digit. Better than 2009, but the growth will be driven by the existing customers as they begin to leverage the services industry expertise to make their systems more efficient. The growth in revenue seen in FYQ2’10 is seen as cyclical growth, not as a one-time budget flush activity.

While manufacturing industry is lagging this year, the retail industry has been the driver so far. FYQ3’10 sees an increased traction in the financial business, partly driven by the M&A transactions in Europe. Infosys has been able to break into more non-UK based contracts by winning a contract with 2 German utilities companies. Its insurance sector is also seeing growth in the asset management and health care sector.

Supply side: Aggressive lateral hiring

As Infosys enters the high-end consulting business, it finds the need for hiring more middle managers with experience. At the same time, they are trying to de-risk immigration employee related revenues from the US, since 30% of the revenues currently come from work done at the client site. While the management doesn’t see an upside to the 20000 number, the utilization level lever will likely be used to address any upside in demand in calendar year 2010.

Infosys continues to build up its base in low cost Latin American countries as well as Europe to strengthen its global delivery network. On the wage front, Infosys surprised the investment community and competitors by increasing pay by 8% on the average for Indian employees and by 2% for US employees. Based on my industry checks, It appears that this move is seen as necessary to keep the valuable employees who can contribute to value added services where INFY doesn’t have much presence.

Higher margin or Higher revenue?

Infosys prides itself as the industry wide leader in operating margin. However, it might be too conservative in investing for future growth. INFY needs to recognize that the services industry is becoming commoditized and needs to focus on revenues rather than margin to help drive the future growth. As Infosys moves into high end consulting, it comes with increased expense in SG&A and R&D.

Infosys has to be comfortable with spending more in order to compete with the multinational companies like IBM (NYSE:IBM) and Accenture (NYSE:ACN). Despite the fact that Infosys is accelerating the hiring of employees with experience and is slowly getting exposure in the high end consulting market, the continued importance given to higher margins might limit its growth in the future. Despite the management’s intent to keep margins around 30%, the wage pressure and potential stronger rupee will squeeze the bottom line.


The stock is currently priced at 24.2x FY2010 average consensus estimate of $2.14. Looking at the trailing twelve month earnings of $2.25, it is priced at 23x. As the wages increase, the rupee strengthens and hiring increases, margins get pressurized, but the utilization lever and stable pricing scenario could offset that. While INFY has given conservative guidance to EPS in the past, given the historically weak December quarter due to less working days and cautious customer base as we move into 2010, the upside to the stock is limited at the current level. I believe that the 12 month target for INFY is $50, given on a P/E multiple of 23x of FY2010 earnings of $2.14.

Author's Disclosure: no long/short positions held