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Suresh Krishnamurthy

THOSE who have invested in the Infosys Technologies stock can book profits now and re-enter when the valuations are more attractive. The current valuations require the stock to grow upwards of 15 per cent for a fairly long period to deliver reasonable returns. Given the volatility that profit growth rates may be subject to, it would be prudent to sell now and re-enter later.

Suitability: The recommendation is suitable to investors with a conservative risk profile. Re-evaluation, though, would become necessary if subsequent events indicate that the rate of growth in earnings beyond March 2003 is likely to be significantly above the 15 per cent range.

Investors also need to consider that the Infosys stock price was subject to a high degree of volatility last year.

Since factors affecting growth expectations are still subject to uncertainty, the continuation of high price volatility is likely.

Commendable performance: What stands out in Infosys' performance is that the 2001-02 events have vindicated the conservative approach of the company's management.

In April 2001, the company forecast a 30 per cent growth in per share earnings, and achieved it.

Given the negative factors that were at work, the performance should be considered commendable.

In fact, there is a more impressive side to Infosys' performance — the cash flow picture.

The operating cash flow did not at all deteriorate this financial year despite the slowdown in growth rate, fall in billing rates, lengthening sales cycle and the intense competition. Operating cash flow rose 51 per cent during the year on improved debtor collection period.

Still, the fourth quarter performance shows distinct signs of the impact of intense competition.

While revenues rose 2.9 per cent over the quarter ended December 2001, the operating profit after depreciation actually declined by 0.1 per cent.

Only a sizeable jump in `other income' led to the rise in net profit by 2.1 per cent over the quarter ended December 2001.

Even in the area of customer accretion, the news is mixed. The number of million dollar clients fell to 83 at end-March 2002 from 90 at the end of December 2001.

That Infosys managed to add 29 new clients during the quarter - roughly the same as in earlier quarters of this financial year - is, on the other hand, positive.

Key issues: The key issue relating to the valuation of Infosys revolves around the expected rate of growth beyond the year ended March 2003. For the coming financial year, Infosys expects per share earnings growth of between 15-18 per cent. However, will the rate of growth exceed this range in the years beyond March 2003? The expected returns are highly sensitive to this factor.

The expected growth depends partly on how the war chest of Rs 1,000 crore would be utilised. Cash now accounts for roughly 50 per cent of Infosys' net worth. If this is used to acquire an undervalued software services firm, then expected growth rate in earnings will change significantly.

Another critical issue relates to the foray into business process outsourcing. Infosys has indicated that the diversification will be made through a subsidiary with an initial investment of $5 million.

If the ramp up in BPO happens in the near term, it can positively influence the valuation.

However, for now, to expect sustained growth of 15 per cent or more well into the future borders on optimism, considering the uncertain emerging global scenario.

Investors can as such book profits and re-enter at lower levels of valuation. The stock trades at a price to earnings multiple of 32 times its per share earnings for the year ended March 2003.

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