Infosys repays faith with stellar Q2 performance; stock gains over 4%

Valuation gap between Infy and TCS is unlikely to narrow further

Unlike Tata Consultancy Services (TCS), Infosys’ (Infy) September quarter results did not disappoint the Street. 

While Infy’s revenue growth was a tad lower than what analysts had forecast, it outperformed on the margin front. The IT services firm reported an Ebit (earnings before interest and tax) margin of 21.7 per cent, a rise of 120 basis points (bps). Analysts had pegged the increase at 100 bps.

However, what the Street will keep an eye out for, on Monday, is the revision in growth estimates by the company. A second consecutive upward revision is widely expected.

In fact, the management’s optimism is in sharp contrast to the cautious tone adopted by TCS regarding growth in the second half of the financial year. 

Infosys revised its FY20 revenue growth guidance, in constant currency terms, to 9-10 per cent, from 8.5-10 per cent given at the end of the June quarter. 

Its March quarter guidance stood at 7.5-7.9 per cent. While the revision was not unexpected, doubts would nevertheless have crept in, especially after TCS’ growth outlook.

What should help Infy boost its top line is large deal wins, which rose 75 per cent year-on-year in H1FY20 to $5.5 billion. 

This is a positive, amid concerns for the sector about European banking and capital market space and retail.

In the September quarter (Q2) some pockets of financial services pushed up the segment’s revenue by 10.3 per cent year-on-year, in constant currency terms, for Infosys. 

In fact, barring retail (up 1.1 per cent) all other verticals of Infosys grew in double digits (10-19 per cent), year-on-year in constant currency terms. 

The margin-accretive digital business, which now contributes to around 38.3 per cent to Infosys’ overall revenues — as compared to 35.7 per cent in Q1 — too grew a sharp 38.4 per cent year-on-year in Q2 in constant currency terms. 

However, there are worries over near-term margin gains.

“Though the strong growth of Infosys is positive, it is likely to keep future gains on this count limited. We expect Infosys’ Ebit margin for FY20 to be around 21.5 per cent,” says Sanjeev Hota, head of research at Sharekhan. 

The Infosys management is confident of achieving its FY20 margin guidance of 21-23 per cent on faster growth of digital business, cost efficiency, and overall operational improvement, such as higher utilisation, as was the case in Q2. 

Overall, the fact that Infosys outperformed TCS in Q2 could get reflected in Monday’s trading session. Infosys gained 4 per cent on Friday, while TCS closed in the red. 

However, Hota believes the valuation gap between TCS and Infosys is unlikely to narrow further, given the leadership position and size of TCS. 

Infosys’ current valuations at 19x its FY21 estimated earnings is now at a 7 per cent discount to TCS, versus 20-22 per cent discount earlier.