Infosys ripe for re-rating after strong performance in June quarter

While the company's revenue grew by 8.5 per cent year-on-year to Rs 23,665 crore, its profit before tax (pre-tax profit) was up by 12.1 per cent year-on-year

Infosys’ June 2020 quarter (Q1) results are the best, so far, in the sector, not only in terms of the firm beating the Street’s expectations but also the management's revenue guidance. And this improves the earnings and re-rating potential of the stock.

While the company’s revenue grew 8.5 per cent year-on-year (YoY) to Rs 23,665 crore, its profit before tax was up by 12.1 per cent YoY to Rs 5,792 crore. Analysts had pegged these at Rs 22,966 crore and Rs 5,116 crore, according to Bloomberg. The higher bottom-line growth was led by a 220 basis point YoY expansion in operating profit margin to 22.7 per cent. Like other IT players, which have reported their Q1 results so far, lower costs fuelled Infosys’ operating profit. Currency depreciation, too, helped. 

In constant currency (CC) terms, Infosys' revenue was down 2 per cent sequentially, but up 1.5 per cent YoY. The other two tier-1 domestic IT players — Tata Consultancy Services (TCS) and Wipro — have reported a 4-6 per cent YoY decline in CC revenue.

What's more important is that at a time when the near-term demand scenario is uncertain and analysts expect other IT players to post contraction in FY21, Infosys has guided for 0-2 per cent CC revenue growth for FY21, with a 21-23 per cent Ebit (earnings before interest and taxes) margin. Therefore, some analysts expect Infosys' FY21 earnings to get revised upward by up to 8 per cent.

 

 

Amit Chandra, analyst at HDFC Securities, said: “With strong Q1 numbers and growth guidance by the management, Infosys’ further re-rating potential has improved.” The valuation gap between Infosys and TCS would narrow, he added. At 21.8 times FY21 estimated earnings, Infosys is trading at a 19 per cent discount to TCS’ stock. The management eluded that strong client connect is helping the company drive growth and the digital segment remains a key growth area. Digital transformation, cybersecurity, and automation will be key growth areas for the entire IT sector.

In Q1, Infosys’ digital revenue surged 25.5 per cent YoY in CC terms. Though the growth rate is lower than in the past, it is noteworthy in the current environment of a demand slowdown. The revenue share of the digital business, too, shot up to 44.5 per cent in Q1FY21, from 41.9 per cent in the March quarter and 35.7 per cent a year ago.

What is also notable and supported Infosys’ performance in Q1 is a 2.1 per cent year-on-year increase in the financial services segment's revenue (in CC terms). Analysts believe the performance of the banking, financial services and insurance (BFSI) vertical, which accounts for 31 per cent of Infosys' revenue, was mainly driven by deal wins. The BFSI performance is noteworthy as the other top players (TCS and Wipro) have reported a 5 - 7 per cent revenue decline in this segment.

Given the lower spending power of banks amid the poor earnings outlook, the jury is out on whether Infosys can sustain the growth momentum in the BFSI segment. Some other segments, such as manufacturing and retail, which were under pressure are stabilising, said the management, offering further comfort. Infosys ADR was up 13 per cent at 7.30 pm IST.