Similar to its peers in the sector Infosys, too, reported mixed Q1 results – while revenue momentum is strong, cost pressures have impacted profitability. However, Infosys’ results at a broad level can be viewed as the best amongst its peers in the Indian markets. At a global level, Accenture’s results appear to be better than that of its Indian counterparts.

Growing faster than peers

Infosys reported a revenue of Rs 34,470 crore, which was 1 per cent above consensus. However, operating income (EBIT) of Rs 6,914 crore was 3 per cent below consensus. The operating margin at 20.1 per cent was below expectations of 20.8 per cent. TCS, Wipro and HCL Tech also reported weaker than expected operating margins.

Where Infosys stands out is its industry leading growth amongst large cap IT services companies. The Y-o-Y constant currency revenue growth of 21.4 per cent reported by Infosys was better than the 15.5 per cent reported by TCS, 15.6 per cent reported by HCL Tech, and 17.2 per cent by Wipro. While Accenture’s constant currency growth of 22 per cent was higher than that of Infosys, it included benefits of acquisition, and adjusted for that, Infosys growth is numerically better. It, however, needs to be noted that Accenture’s growth can be viewed as qualitatively better as it is comes off a much higher revenue base versus its Indian peers. 

Further, Infosys is also racing ahead of the pack with its increase in revenue guidance. It expects FY23 constant currency revenue growth at 14-16 per cent, versus prior guidance of 13-15 per cent. The business momentum across verticals and geographies was strong, with double digit constant currency growth across the board (except for India business). The high-growth digital business now represents 61 per cent of total revenues. Management commentary was broadly positive, with a tinge of caution – while the current momentum remains solid, there are possibilities of weakness in the mortgage business segment within the BFSI vertical.

What tempers this solid business momentum is margin weakness and high attrition rates. Management now expects its FY23 EBIT margin to come in at the lower end of its 21-23 per cent guided range. This takes away some of the sheen of its revenue growth. In FY22 Infosys had reported an EBIT margin of 23 per cent. Thus, while revenue growth is good, the benefits are not flowing through to shareholders because of the margin compression. Another aspect of concern is that the last 12-month attrition at 28.4 per cent is high and needs to be addressed by the management.

What should investors do?

In reaction to the results, Infosys has been trading flat. At the current price of Rs 1,498, it is trading at one-year forward PE of around 25 times. This is an approximately 20 per cent premium to its five-year average. While there is a case for some premium to historical valuation, given it has been the best performer in terms of growth amongst the tier-1 players in the last 2-3 years, the margin compression it faces can keep the shares under pressure or sideways for some time. While margins will improve as the company optimises its current investments (including in talent), there is also the risk that by the time operating leverage kicks in a few quarters down the line, revenue momentum may have temporarily faded due to the global slowdown.

Also, at an absolute level, the forward PE of 25 times is not cheap for a stock which is expected to deliver FY21-23 earnings CAGR of around 13 per cent.

Due to margin compression, earnings growth is  getting impacted, despite its solid revenue growth. Infosys’ Y-o-Y earnings growth in Q1 was just 4.4 per cent in rupee terms, and was flat in USD terms. For the same overlapping period (i.e. quarter ending May), Accenture was able to grow its earnings by 16 per cent in USD terms and was even higher when adjusted for a one-time impact related to a write-down of Russia business. Accenture trades cheaper at a one-year forward PE of around 24 times.

Given the above factors, investors can wait and watch when it comes to the Infosys stock. Better entry points are likely sometime over the next few quarters.

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