Infosys: Lower cost pressure, digital business may aid profit margins

The September quarter (Q2) results of Infosys indicate the company may be seeing a turnaround in its growth trajectory. While this is a positive, Infosys will need to do a lot more to win back investor confidence.

After three quarters of dismal performance as compared to TCS, Infosys reported healthy revenue growth of 4.2 per cent in constant currency (CC) terms on a sequential basis on Tuesday, after market hours, ahead of TCS’ 3.7 per cent. Revenues at Rs 206.1 billion also beat Street expectations of about Rs 203 billion.

Moreover, it was a broad-based sturdy quarter on the revenue front. Its two major verticals, financial services and retail, which account for about a half of Infosys’ revenue, sequentially grew 5.8 per cent and 5.9 per cent, respectively, in CC terms. 

The management expects the momentum to continue, amid strong deal wins in the last two quarters and improving demand from the US. 

Infosys won contracts worth over $2 billion in Q2, its highest ever, indicating brighter growth prospects.

With the rupee depreciating by over 5 per cent against the dollar in Q2, the Street was expecting improvement in operating margin. However, unlike TCS, Infosys’ earnings before interest and tax (EBIT) margin remained flat at the June quarter level of 23.7 per cent. Margin benefits of 80 basis points, arising out of a weak rupee, were mainly offset by higher sub-contracting charges in Q2. The Q2 margin number also suggests Infosys is investing back into the business for faster growth, initial results of which are now showing. However, analysts aren’t too concerned with margins, seeing an upward traction over the rest of FY19.

“Though higher sub-contracting charges impacted margins, it indicates an improving demand scenario. With cost pressures like wage hike and visa charges now behind, we believe margin will rise in the ensuing quarters and comfortably breach the upper end of Infosys’ guidance of 22-24 per cent,” says Sandip Agarwal, analysts at Edelweiss Securities. 

Moreover, the highly profitable digital business continued to grow fast, though growth was slower than TCS, with 13.5 per cent expansion sequentially and revenue share rising to 31 per cent in Q2 from 28 per cent in Q1. This confined the downward margin risk in Q2 and is likely to aid profitability, say analysts.

Reacting to the results, Infosys’ American Depository Shares (ADS) surged over 5 per cent (9 pm IST).

For now, while Q2 does indicate that the growth trajectory is reviving, for investor confidence to improve this trend needs to sustain.