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| Signs of recovery |
| Sarath Chelluri / Oct 12, 2009, 00:26 IST |
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An improving global environment, preparing new models to capture growth and ability to sustain margins augur well for Infosys
 Among the bigger companies, Infosys was the first to kick-off the September quarter (Q2) results season and brought some cheer with it. Outsmarting its own Q2 revenue guidance provided earlier by 8.5 per cent to $1.154 billion and upgrading the guidance for the full year indicate were some positives.
However, the Street wasn’t too much surprised as the results were only a shade above market expectations. The September quarter results also show a brighter volume picture even though pricing scenario hasn’t improved majorly. For most of last year, emphasis on cost-light structure partly helped churn better margins. Additionally, favourable currency movements added to the margins.
However, with an eight per cent increase in employee salaries and an upward pressure on the rupee, these could eat some margins off in the future quarters. A probable recovery in economic prospects as many experts are predicting in 2010, should see IT players benefit with greater business.
Recovery on the horizon
The global economic growth might have come off with the US economy in doldrums. Nevertheless, things appear to be stabilising in the US after a forgetful 2008, which is positive of the Indian IT sector. In terms of global IT spending, US accounts for 35 per cent of global IT spends and prospects of Uncle Sam’s economic revival would hasten the growth trajectory of the domestic IT vendors.
As per Forrester, US IT purchases would increase by 7.7 per cent in 2010 compared to a decline of 9.3 per cent in 2009. As ground realities change, IT bellwether Infosys, with envious track-record in terms of management and scale, would be the foremost to take advantage of a turn in the US economic growth cycle as three-fifths of its revenues originate from US. Europe is not out of the woods and its recovery is expected to come with a lag. UK could be the first one to come out of the hibernation from Europe, as per the management.
An improvement in business environment should trickle in with better volumes. A pick-up in volume growth of 2.3 per cent reported by Infosys in Q2, against a volume decline of 1.1 per cent sequentially (Q1), renews confidence of a change in climate. What has helped in delivering better volumes is the addition of new clients (35 of them) and extraction of better volumes from its top 10 clients.
The cushion from volumes changed tide to post positive revenue growth of 2.7 per cent after consequent two quarters of revenue decline. Among verticals, a recovery in BFSI segment, extra spending in utilities and improvement in retail helped post higher revenues. Nevertheless, manufacturing and telecom verticals are yet not out of the woods.
However, management maintains that clients are still cautious and decision time-cycles have not lessened dramatically. Consequently, the company has given a cautious consolidated revenue guidance in the range of $4.6-$4.62 billion; a decline of 1.0 per cent on the last fiscal’s reve nues—this is better than $4.45-$4.52 billion projected at the end of Q1.
| COST CONTROL GAINS |
| in Rs crore |
Q2 FY10 |
(q-o-q) |
% change
(y-o-y) |
| Total Income |
5585 |
2.1 |
3.1 |
| Software dev exp* |
2963 |
1.6 |
2.5 |
| SGA expenses# |
689 |
0.0 |
-6.0 |
| Operating profit |
1933 |
3.5 |
7.7 |
| Other income |
236 |
-12.3 |
257.6 |
| Net profit |
1540 |
0.9 |
7.5 |
# Selling, General & Administrative expenses
* mainly staff costs
Source: Company |
Margin surprise
In the last few quarters, the company reinvigorated its sales and marketing teams and started increasing local hiring to reach out to clients better. In spite of these cost pressures, Infosys managed to deliver operating margins of 34.6 per cent, an increase of 50 bps sequentially.
Stable employee utilisations, greater off-shoring volumes and favourable currency gains, helped report better than expected margins. While the company has seen volumes rise in the US, enhancing the sales force focus in Europe should help deliver greater business from there in the future. Besides clients, the company is gearing towards higher business off-take by shifting focus to its employees through employee additions and salary hikes.
The management expects that hikes (8 per cent for offshore employees, 2 per cent for onsite) across the board would eat away 200 bps from margins for the next two quarters. Thus, expect the margins to be in the range of 32.5 to 33.5 in the coming two quarters.
| DEPENDENT ON IT SPENDING |
| in Rs crore |
FY08 |
FY09 |
FY10E |
FY11E |
| Net sales |
16,692 |
21,693 |
22,539 |
26,465 |
| EBITDA |
5,238 |
7,195 |
7,503 |
8,682 |
| EBITDA (%) |
31.4 |
33.2 |
33.3 |
32.8 |
| Net profit |
4,659 |
5,988 |
6,044 |
6,761 |
| EPS |
81.5 |
104.7 |
105.7 |
118.2 |
| P/E |
-- |
20.8 |
20.6 |
18.4 |
| E: analyst estimates |
Conclusion
The IT budgets of global companies should be finalised by the end of the year or at worse by early 2010. Although there is an expectation that spending could either be flat or with modest increases, Infosys management has been cautious in upping its revenue guidance for 2009-10. The company’s confidence in terms of future growth is also visible from its announcement to increase employee strength by 2,000, mainly experienced personnel (this would help capture any potential upturn in the business cycle), by March 2010.
The company is observing good traction in high growth areas like business process management, infrastructure management and system integration. However, consulting services would be able to deliver better rates only in the future, as IT spends need to stabilise before any pick-up could materialise.
The company has also been laying emphasis on non-English speaking markets in Europe like France, and it also looking in India for future growth. Infosys might look to acquire companies that would allow its access to preferred geographies and ones that would be complementary to its existing service areas.
The management says that it would ideally be looking at companies at one-tenth of its size as probable acquisitions, and has cash of around Rs 9,700 crore which suggests that funding would not be a problem. At Rs 2,178, the stock is trading at 18.5 times its estimated 2010-11 earnings. Adding on dips would a good strategy.
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