Stock Review: INFOSYS Technologies

 

  INFOSYS Technologies' financial performance has been sluggish in the last six quarters, when its peers reported faster growth. The company, which is India's second-largest IT exporter, posted lower than 10% growth in net profit for two consecutive years ended March 2011.

   Following the depressed numbers, the company's stock has lost over 12% of its market capitalisation since its announcement of fourth quarter results. The fall, one of the steepest in recent times, has raised concerns over the company's status as an industry bellwether. Investors need to trade cautiously in the scrip, given the possibility that the company may take longer than expected to regain growth momentum amid intense competition from other Indian and overseas IT services and technology consultancy players.

PERFORMANCE:

What went wrong?

   Infosys has reported a slowing growth momentum at a time when global outsourcing demand has picked up. While the IT exporter has gained new clients and bigger multi-year accounts in the last four quarters, this has not escalated its profit growth. What could be of more concern is the fact that some of its bigger and smaller peers have been able to post better growth. Companies, including TCS, HCL Technologies, and Cognizant Technology Solutions Corporation, which is not listed publicly in India, have reported better revenue growth backed by higher business volumes and improved employee utilisation. The contrasting performance of Infosys compared with its peers highlights issues relating to its growth strategy.

   For long, Infosys has employed an organic growth model with a sharp focus on margin maximisation. The company built some of its capabilities through acquisitions, but this was largely restricted to smaller takeover targets. As it appears now, its higher focus on profitability restricted its investments in widening its reach and improving deliverables. In contrast, TCS and HCL Technologies invested heavily to acquire substantially larger companies across geographies.This seems to have served as a major differentiator.

ROAD AHEAD:

Infosys' FY12 earnings forecast appears too conservative though its management has reiterated that demand will remain strong. The company sees net profit growth of 5-7% in FY12, which would make it the third consecutive year of single-digit growth. It has also guided for a 300-basis point decline in its operating margin. Lower staff utilisation and currency swings are cited as major concerns, which could erode profitability. On a positive note, the company will add a higher number of employees in FY12, which reflects demand visibility. It has also reported greater traction in large transformational deals.

VALUATIONS:

At the current price level, the company's stock trades at FY12 estimated P/E of over 23, which is lower than its historical range of 25-30. It may erode further if the company fails to match the performance of its peers in coming quarters. The company is in the process of identifying the future course of its leadership, which will be crucial in determining its growth trajectory. With no firm signs of a quick reversal in its sluggish growth trend, the stock is likely to remain rangebound. Investors may prefer the stocks of other top tier IT exporters in the medium term.

Key factors

Positives

• Sustained double-digit client addition in the last five quarters, which reflects a firm demand traction

• An improved hiring target indicates a better revenue visibility in the near term

• A gradual positive shift in billing rate trend for top IT companies

• Over 16,666-crore strong cash balance to help inorganic strategies

Negatives

• Slower growth in majority of key verticals

• Steeper attrition rate may put pressure on wage costs

• Relatively negligible presence in the fastgrowing Indian IT market