Infosys: Volatility is the new normal

Company’s weak earnings guidance implies crisis of confidence more than margin erosion

When it comes to earnings, markets reward consistency. Infosys has consistently beaten its guidance prediction for over a decade now. So, it isn’t surprising that the market hammered the stock on Friday (which closed 9.6 per cent down at Rs 2,988.80), after the company failed to meet market estimates. Revenue grew by two per cent quarter-on-quarter to Rs 7,250 crore (against consensus estimate of Rs 7,450 crore) in the March quarter, while the same grew by 1.2 per cent in dollar terms to $1,602 million. Ebitda margin for the fourth quarter stood at 29 per cent (against consensus estimate of 30.6 per cent), reflecting an erosion of 132 basis points year-on-year. The market is used to Infosys beating its earnings guidance by a good five-seven per cent margin.

In a conference call with analysts after announcing the results, the company attributed its muted performance on currency volatility, lower employee utilisation of 75 per cent (excluding trainees), against the usual 78-79 per cent and headcount addition. Interestingly, in the December quarter, the utilisation was 80.7 per cent. Commenting on causes for margin erosion, the management said that we live in times where ‘everything is volatile – growth, currency, etc’.

Analysts believe this is an early indication of the state of the outsourcing industry. While the top team of the IT bellwether claimed they were confident of a normal year ahead, their earnings guidance seems to suggest otherwise.

Even as the management seemed to suggest this will be a normal year, they clearly expect volatility in business and projects to continue, especially in verticals like insurance and telecom. This is reflected in their recruitment. The company had indicated they would hire 25,000 in FY11, but ended the year with 43,000 and a utilisation level of 75 per cent. Analysts say this implies lack of clarity on business, as companies mostly add to the headcount depending on business visibility. Whether the March quarter is an aberration or otherwise, the picture will be clearer when June numbers are declared. Meanwhile, for this to happen to an Infosys is a worrying sign.

The days of high growth and even higher earnings are seemingly over. Analysts have been prepared to see margin dilution, as Infosys would find it difficult to hold on to a 30-plus per cent margin in a highly competitive environment.

But nobody was prepared for such a watered-down earnings outlook. Infosys guided for 18-20 per cent dollar revenue growth at $7.2 billion, against analyst expectation of 20-22 per cent year-on-year growth. Infosys has guided for its rupee EPS (earning per share) of Rs 126–128, a growth of 5.5–7.3 per cent year-on-year. This is significantly below the expected EPS of Rs 138–140.

According to analysts, a muted guidance on earnings suggests there is pressure on costs. Says Kartik Mehta, AVP research at Sushil Finance: “Infosys may witness margin erosion of about 250 basis points in FY12 due to higher sales costs, currency appreciation and salary hikes. Earlier the Street was expecting margin erosion of 100 basis points, but the earnings guidance implies that margins may erode by 250-300 basis points.”