Deal wins, margin surprises likely to power more gains for Infosys

Enhancing digital capabilities should aid growth amid rising IT budgets

Recent acquisitions, strong deal pipeline, and rising digital spends should help Infosys, the country’s second-largest software company, maintain its growth outperformance. Higher growth and steady margins should also help it bridge the valuation gap with larger peer TCS.

While the stock gained 10 per cent this month on the back of sectoral rerating and earnings upgrades, analysts highlight multiple triggers which should support its financials and valuations — among them is its acquisition strategy.

The company announced two of its three acquisitions this year in September. The acquisitions are small in deal size ($35-$42 million each) and won’t move the needle much in the near term on revenue growth. However, Suyog Kulkarni of Reliance Securities believes they will help Infosys build additional capabilities and refresh digital offerings.

Commenting on the acquisition of Kaleidoscope Innovation earlier this month, analysts at Axis Capital, led by Shashi Bhusan, believe it will strengthen the company’s digital offerings for consumer and medical industries by adding upstream offerings of product innovation and design. They expect the acquisition and recent large wins to aid a strong recovery for Infosys.

Given its capabilities, analysts expect the company to be a key beneficiary of the accelerated pace of IT spends and vendor consolidation brought on by the pandemic. Analysts at Kotak Institutional Equities believe the company is well positioned because of low exposure to legacy infrastructure management services and accelerated pace or pull-forward of spends. Infosys gets nearly 45 per cent of its revenues from digital segment — the highest among large-cap peers — and should benefit from the ongoing trends as 80 per cent of incremental spends over the next five years will be digital technologies. Some of these trends have started reflecting in deal wins for the IT major. 

After its sharp outperformance in the June quarter, the company is expected to maintain its upward trajectory on the deal front. After reporting $1.75 billion of deal wins in the June quarter, the company announced its single-largest multi-year deal with US investment firm Vanguard in July, pegged at $1.5 billion. This was followed by deals with German specialty chemicals maker LANXESS, US energy company Consolidated Edison, National Bank of Bahrain, and Genesys Partner, a customer service consultant. The large deals offer revenue visibility over the medium term.

Though the company has maintained its margin guidance in the 21-23 per cent band, analysts at Motilal Oswal Research expect further expansion in profitability as investments stabilise and back-ended productivity benefits kick in. While there are headwinds in terms of higher onsite presence and a stronger rupee, operating leverage, higher automation, and lower sub-contracting expenses are expected to provide support.

While some of the gains after the Q1 results are captured in the stock, which is up 37 per cent since the start of July, and has nearly doubled since its March lows, there is an upside of 10-15 per cent over the recent consensus target prices of brokerages. Though the stock at 24x one-year forward price-to-earnings ratio is trading at a 20 per cent discount to TCS, analysts expect the discount to reduce due to growth outperformance, management stability and improved margins.