Infosys: Improving demand outlook

The company’s strategy to cross-sell and provide value enhancing services to its customers helped it garner higher revenues from its top 10 clients.

Infosys Technologies’ December 2009 quarter results not only outshone the Street’s expectations and its own guidance but, also indicated that the future looks brighter. Not surprisingly, Infosys stock surged four per cent and pushed up the IT index by a similar margin, on a day when the Sensex fell by about half a per cent.

With demand reviving, volumes were up by 6.1 per cent. The company’s strategy to cross-sell and provide value enhancing services to its customers helped it garner higher revenues (up 12.2 per cent) from its top 10 clients, which saw the latter’s contribution to revenues reach the highest in the last three quarters. Overall, good traction from North American customers and the banking and financial services (BFSI) segment coupled with steady pricing environment helped Infosys report a 6.8 per cent sequential growth in revenues, which is the highest in the last seven quarters.

While North America saw its share in revenues grow further, the recovery in the European region is expected to come with a lag-effect; here, improving prospects in Germany and France provides some comfort for the future.

At the operating level, profit margins improved by around 90 basis points to 35.5 per cent on account of pricing stability and better utilisations. The employee utilisation rate (excluding trainees) improved 300 basis points to 76.2 per cent and added about 80 basis points to margins. Notably, there is scope to improve this further, which could help mitigate any margin pressures going ahead. However, the strengthening of rupee by 3.6 per cent during December quarter impacted overall margins by 120 basis points. Going ahead, unfavourable currency movements, salary hikes and an increase of hiring targets put together could put some pressure on the margins. On these counts, the management expects margins to decline by about 150 basis points in the March 2010 quarter.

At the net level, increased tax provisioning due to higher proportion of revenues accruing from delivery centres outside India and non-STP (within India) areas, restricted profit growth to 2.7 per cent in the December quarter (profit before tax was up by 5.2 per cent).

Going ahead, with pricing environment stable and customers taking decisions faster, the ongoing global economic recovery suggests that the demand environment should improve further. The management has also indicated that large deals are returning; it won a $200 million deal in the quarter. Even as IT budgets are yet to be finalised, the up-tick in Infosys’ full-year guidance instils confidence of better days ahead. At Rs 2,587, the stock is trading at 24.2 times its 2009-10 earnings estimates, and may be considered on dips.