December Results Above Consensus Estimates
India’s leading IT company Infosys (NYSE:INFY) reported results for the December quarter [fiscal 3rd quarter for year ending 03/2023] that were above consensus estimates. EBIT grew by 5% QoQ, and a healthy 10% YoY. Net Income was up 9% QoQ, and 13% YoY. Despite a challenging global macro backdrop, management’s commentary on the demand environment and deal pipeline remained strong and raised revenue growth guidance in constant currency terms to 16-16.5% (vs. earlier 15-16%) and maintained EBIT margin guidance of 21-22% for FY23E. We expect INFY to continue to gain market share in technology adoption due to several secular trends. In view of strong deal wins, strong revenue guidance, healthy margin territory and attractive valuation, we would add to this stock on weakness. We value the stock at US$22.00, based on 22x forward estimates.
Large deals to drive growth
Infosys is seeing strong growth in digital and core growth. During the current quarter the large deals were more in renewals, led by vendor consolidation & client cost reductions opportunities. In our opinion, Infosys will be a key beneficiary of this trend for the next several years given the company’s ability to win market share and help clients in optimizing tech spends. This coupled with large deal wins and healthy pipeline bodes well for top-line and bottom-line growth.
Worst over for Margin Concerns
Cost pressures [mainly inflation-induced and attrition-related upward pressure on wages] have been a key concern of the entire Indian IT sector. We believe margins have now bottomed out, and will diminish as a concern along with reduced concerns on overall global inflation. Hence, we expect margins to improve going forward led by easing of supply side challenges, leveling-off of sub-con cost, and expense rationalization. Hence, we have assumed 21.3% margins for FY 03/23E and further 93 bps & 30 bps improvements in FY 03/24E & FY 03/25E to 22.2%.
Large Deals a Positive
A key positive for the December quarter was large deal flow. In the dominant USA market, Infosys signed US$3.3 billion in deals, up 20% QoQ and 30% YoY. Infosys and competitor TCS [India: TCS] are well poised to gain market share through large deal wins going forward, in our view.
Infosys Company Description & Business Focus
Infosys is a leading provider of consulting, technology, outsourcing and next-generation digital services, enabling clients around the world to create and execute strategies for their digital transformation. The company also provides digital marketing, artificial intelligence, automation, analytics, engineering services, and Internet of Things services among others. Key industries served by the company are financial services, insurance, manufacturing, telecom, retail, and consumer goods.
The company’s business segment are enterprises primarily in Financial Services and Insurance (over 30% of sales), Retail (some 15%), Communication (over 10%), Energy, Utilities, Resources and Services (over 10%), Manufacturing (roughly 10%), Hi-Tech (nearly 10%), etc.
About 95% of sales were generated from software services. Software products and platforms account for the rest. Headquartered in Bangalore, India, currently has presence in more than 245 locations across about 55 countries. Sales from North American markets account for more than 60%, followed by Europe with approximately 25%, India with less than 5%, and the rest of the world accounts for the remaining sales.
The company’s revenue increased 20% from $13.6 billion in FY 02/2021 to $16.3 billion in 03/2022. This was primarily attributable to an increase in digital revenues, deal wins including large deals and volume increases across most of the segments. In FY 03/2022, the company had a net income of $3 billion, a 19% increase from the previous year’s net income of $2.5 billion.
In addition the aforementioned points on growth and client wins, other issues to note are:
- Rupee depreciation that could aid earnings, as Infosys benefits from a weaker local currency; we estimate that every 1% drop in the Rs/US$ helps earnings by 1-1.5%
- Strong economic activity in the US, by far the largest export market for Infosys (61% of revenues)
- Continued cost-cutting and outsourcing at US and European clients
- Better margin management from operating leverage
Key Risk Factors
- Rupee appreciation that could hurt earnings, as Infosys benefits from a weaker local currency
- Higher than expected workforce attrition, changes in executive leadership
- Adverse immigration regulations which could hurt the company’s ability to staff its projects at US/UK client locations
- Weak economic activity in the US or a recession
- COVID risk on business and travel activity
Conclusion: Buy on Weakness
Infosys is a quality company with secular growth. EPS 5-year CAGR has been 10%, and revenue 11.7% 5-year CAGR, despite a global recession and COVID. The stock is down -26% from last year’s highs. There is strong demand from global fund managers for quality Indian ADRs which they can buy in developed markets [such as the NYSE in the USA], so there is always some level of positive demand flow for INFY’s USA shares. Buying stocks locally in India’s market is a very cumbersome procedure involving getting an FII license or using Promissory Notes [P Notes] issued by large brokers.
We expect INFY to continue to gain market share in technology adoption due to several secular trends. In view of strong deal wins, strong revenue guidance, healthy margin territory and attractive valuation, we would add to this stock on weakness. We value the stock at US$22.00, based on 22x our forward estimates.