Infosys' Weak Outlook: Appreciating Rupee, Rising Wages To Blame

Infosys (INFY) profit rose 34.5% but its full-year outlook was cut due to a rising rupee, according to MarketWatch:

Net profit for India’s second-largest software exporter rose to 10.79 billion rupees ($268.8 million) in the quarter ended June 30, from 8 billion rupees a year earlier. Earnings per share for the quarter rose 31.5% to 18.89 rupees (47 cents).

Infosys said it was reducing its earnings-per-share forecast for the full year, in accordance with Indian accounting standards, to at least 78.20 rupees from its April forecast of at least 80.29 rupees. It made the revision because of a sharp appreciation of the Indian currency against the U.S. dollar.

In dollar terms, the company’s revenue of $928 million and earnings per share of $0.46 were better than the analyst estimates of $909 million and $0.40. However, full-year guidance of $4.0 - $4.05 billion in revenue and $1.92-$1.94 in earnings per share are disappointing. Analysts were expecting $4.07 billion in revenue already, and even though the official estimates were for $1.84 in EPS, $0.06 of upside was provided in the past quarter, and investors were surely hoping for more than another $0.02 for the remainder of the year.

When I previewed earnings for this week, I said:

The $0.40 consensus estimate factors in slowing growth, but the degree of earnings surprise has been narrowing in recent quarters. Given my own experience with outsourcing recently and the general employee retention issues, I think we’ll see some disappointments in this sector over the next couple of quarters.

So far, the company is blaming the crunch not on the tight job market but on the rising rupee. Other factors were not written off entirely:

“The sharp appreciation of the rupee against all major currencies impacted our operating margins during the quarter,” said V. Balakrishnan, Chief Financial Officer. “However, our robust and flexible operating and financial model enabled us to maintain our net margins while absorbing the impact of appreciating currency, higher wages and visa costs.

These are all pressures on an employee-centric enterprise founded on the major wage discrepancies between their home country and those of their customers. If wages and the home currency both rise by 10% annually (in many cases it is even faster) relative to customers, it doesn’t take long for that disparity to reverse. And it takes even less time for the disparity to narrow sufficiently to stall out a 30% growth rate.

INFY 1-yr chart:

Comments

[Ciba Gator:]

Care to do the math and show us how long it will take before your 10% wage/10% currency scenario creates any sense of parity between labor costs in the US and in India?

Also care to quantify the employee retention problem with some numbers? Say, compare INFY's employee attrition rate with other industry players such as Accenture or BearingPoint or IBM Global Services?

The headlines say that wage hikes and retention are bad, but looking beyond the headlines at the actual numbers might produce some different conclusions....

2007 Jul 11 04:42 PM

[William Trent1:]

I provided the link for attrition figures.

As for the wage/currency differential, let's say that at time x Indian programmers cost 10% what US programmers cost. Assuming 10% annual relative wage gains and 10% annual relative currency gains (20% total narrowing) it would take less than 13 years for the gap to disappear.

But the gap doesn't have to be even for the demand to slow significantly. Outsourcing may only be attractive when there is a certain gap - say, at least 50% - to make up for the issues related to management, language and other factors. In that case, the relative parity would be reached four years earlier.

The further question is how long investors will pay 35x trailing earnings if the growth continues to slow.

I have been positive on the Indian outsourcing names for more than three years but have always said that the trend would end when it was too hard to grow the employee base as fast as it did the previous year. That has now happened.

2007 Jul 11 05:47 PM

[Frank Li:]

Excellent article.

2007 Jul 11 07:54 PM

[Ciba Gator:]

The rupee hasn't appreciated 10% a year for a consistent period of time. To suggest that overstates reality. Wages in the US are climbing, on a nominal basis, faster than India. So rather than say that Indian engineers get 10-15% more expensive each year, do the dollar comparison--US engineers get 5%=3-4k more expensive each year versus 15% in India = 1-2k). To a buyer, who pays in dollars not in percentages, the US engineer is getting comparably more expensive each year. In any case, there just aren't enough skilled workers in the West to do these jobs and unless US kids suddenly decide they want to spend four years studying for a job that may end up in India by the time they graduate, supply in the West will never meet demand. Meanwhile India is doing a lot to improve the quality of its vast labor force--within the next few years it more likely that hundreds more thousands of people in India will be employable and wage pressure should abate. Now mix in China (where Indian companies are some of the biggest employers of cheap IT labor) and it's highly unlikely that your long-term wage theory is going to hold water.

I think your analysis is short-sighted, focusing on a handful of current data points without looking at the whole picture. Any industry or business has a collection of challenges, but there may be ways to offset those risks. Anyway, where else will you find this growth, margin, and multiple combination in the markets?

By the way, Infosys reported 13.7% attrition. Accenture, a high quality global company, recently reported 18% attrition. Hard to say that Infosys has employee retention issues--if anything they have an advantage in this area.

2007 Jul 11 08:16 PM

[William Trent1:]

Thanks, Frank.

US workers may be getting nominally more expensive, but they are not getting comparably more expensive. As a percentage of US wages, Indian wages are rising. Mathematically, the advantage erodes.

You ask where else one can find the combination of growth, margin and multiple, and my answer is that you will no longer be able to find it in the outsourcers. Margins will be coming under pressure, and I doubt Infosys and the rest can continue to add 30% to their expanding employee base (which is what it takes for a consulting firm to grow). So what you are left with are 35x trailing multiples.

2007 Jul 11 08:41 PM

[sacsharma:]

I agree that the price differential advantage is eroding. About seven to eight years back engineers in India were earning 1/10th of their US counterparts in dollar terms. Now they are earning 1/2 to 1/4th of their US counterparts. The gap is shrinking fast.Companies are outsourcing because they can't find enough people with the required skill set in the US. The cost advantage is there but its significance is slowly getting reduced.
sagecapital.wordpress..../

2007 Jul 14 09:15 AM

[William Trent1:]

True - it is hard to find good programmers. But based on my experience, the quality programmer shortage is a global phenomenon. It is easy to find bodies anywhere, but the really good programmers have all started their own businesses, wherever they happen to live.

2007 Jul 14 10:45 AM