Infosys: Concerns galore

A higher than expected cut in its full year earnings guidance (both in rupee and dollar terms), continuing challenges on the demand front and pressure on operating margins are indications that Infosys’ woes are far from over. Amidst all these operational challenges, experts say, the change in top management is also ill-timed, and is making the Street a bit nervous.

Thus, despite meeting the Street’s expectations, the Infosys scrip plunged 8.5% intra-day before closing 5.4% lower on Friday, as against 0.7% loss for the Sensex and 2.6% for BSE IT index. While its valuations at 14 times FY13 estimated earnings are inexpensive, analysts are sceptical about the company meeting its FY13 revenue guidance of 5% (excluding the recent Lodestone acquisition).

Bhuvnesh Singh and Vaibhav Dhasmana of Barclays Research say, "Infosys now needs to deliver a sequential revenue growth of 3.7% for the remaining two quarters of the year to meet its full-year guidance. Given the last four quarters' revenue growth of 3.4%, -1.9%, -1.1% and 2.6%, this does not seem to be an easy task".

Even after consolidating Lodestone (annual revenues of about $100 million), Infosys may notch 5-5.5% growth in FY13 as against expectations of 6%. The cut in full year rupee earnings by 3% to Rs 160.61 per share was also higher than Street expectations of 2% cut.

Continued stress in Europe as well as on discretionary spending remain major areas of concern. Similarly, within verticals Banking and Financial Services (BFSI), which forms a third of revenues, reported muted growth of 0.6% sequentially. This partly offset gains seen in manufacturing, retail and energy/utilities (grew by 2.8-4.1%). Overall, volume growth was strong at 3.8% sequentially. But, Nirmal Bang analysts notes, “Offshore billing rate hit its lowest level since Q2’FY11, indicating the company could be attempting to drive revenue growth through price cuts.”

A look at the client metrics points out some worrisome trends – its only $300 million client is now part of the $200 million revenue bracket. The number of clients in the $90-200 million and $20-50 million revenue buckets also fell in the quarter.
The 3.5% net profit growth was boosted by 48% jump in other income, offsetting the drop in operating profit. The sharp contraction of 166 basis points in operating margins was largely a function of higher subcontractor costs and wage hikes. Unless Infosys surprises by playing on cost levers (like increasing its relatively low employee utilisation), margin pressure will sustain. Given the weak pricing environment, there is limited scope for any earnings surprise.