Infosys seen faltering on execution, too

FY14 to see further margin headwinds as onsite project costs rise and sub-contracting hurts deal ramp-ups

Investors of Infosys were poorer by Rs 35,000 crore on Friday, as the stock declined 21 per cent. The flow of bad news did not end with the poor numbers. The company addressed analysts soon after the results were announced and the management's commentary further eroded investor confidence. Till recently, the company maintained it had a strategy in place to ride out of the storm. After Friday's commentary, the Street isn't buying any of this, as it is apparent the company is faced with both execution and margin risks.

The execution risks are apparent from the mismatch between volumes and revenue growth. For FY13, volumes rose 8.8 per cent but revenues grew just 5.8 per cent. In the first half of FY13, the company won deals worth $960 million and "though the pipeline remains robust" the management is not confident of its revenue stream, which is why a wide band of 6-10 per cent growth guidance has been given for FY14. This is much below Nasscom's guidance of 12-14 per cent. One of the reasons for Infosys lagging on the execution front is US visas. Given the over-subscription of visas, the company has to sub-contract onsite work. Over the last few quarters, sub-contracting is up two per cent and could increase further. On some occasions project ramp-ups have not happened due to sub-contracting issues. This implies that the company is hamstrung on the execution front as well.

The other headwind that is expected to hit the company in FY14 is lower margins, which will also impact revenue growth. Operating margins have declined from 30 per cent in FY12 to 25.8 per cent in FY13. It has ended Q4 with operating profit margins of 23.5 per cent. Margin headwinds will be the dominant theme of FY14, D Shibulal, chief executive officer (CEO) of Infosys, conveyed to analysts.

There are several factors that will put pressure on margins. The obvious one is pricing, which is under pressure, especially in the application & maintenance business (which is the bread and butter business). The company's onsite efforts have grown 3.7 per cent while offshore is up 0.5 per cent, which means that the company needs more high-cost employees on location.

The other factor is wage hikes. Infosys has given wage hikes of six per cent to offshore employees and three per cent to onsite employees. Given that the wage hikes are higher than the company's revenue growth, Infosys' profitability would take a hit and it will be reflected in the coming quarters. The only solution is growth, as the company's CEO D Shibulal puts it.