Infosys Technologies: Buy

At a time when there is considerable flux in the Asian markets, and more specifically in India, the developed world is showing signs of improving growth. The US, the Nordics and Germany are showing signs of recovery.

Over the last several quarters, pent-up technology spends, including discretionary spending and new opportunities after mergers and acquisitions in developed markets, have benefited IT vendors. This has helped top-tier players such as Infosys take a disproportionate share of the market compared with mid-tiers. The top players have also gained from the process of vendor consolidation undertaken by clients.

In this light, investors with a two-year horizon can consider buying shares of Infosys Technologies, given its healthy service-mix, broad-based recovery across verticals and robust improvements in key metrics that have ensured better realisations.

At Rs 3,046, the share trades at 20 times its estimated FY12 per share earnings. This is at a discount to TCS and is lower than its historic valuation levels. Its cash and cash equivalents alone, at Rs 15,897 crore, translate to about Rs 276 per share, an added comfort factor.

For the nine months of FY11, the company's revenues rose by 20.6 per cent to Rs 20,251 crore, while net profits increased by 8.4 per cent compared with the same period in the previous year. While a slower net profit growth may partly be due to wage inflation, the key factor was a 44.4 per cent increase in tax expense over the previous fiscal. But it is important to note that, at nearly 27 per cent, the tax incidence of Infosys may not increase significantly from here on, while most of its peers may have to grapple with a 3-5 percentage points rise, as they transition operations to SEZs.

Healthy business-mix

After a hiatus, Infosys has seen its high-margin consulting and package implementation services grow by over 37 per cent over the last four quarters, now accounting for 25.9 per cent of revenues.

What has been even more heartening is that its products (Finacle) business has more than doubled and contributes over 5 per cent to revenues.

The management has indicated that these may not just be one-off. While bank mergers and acquisitions and subsequent integration continue to provide significant opportunities, the company is looking at potential in areas such as fraud management, risk management and regulatory compliance, especially in the US.

Apart from the BFSI vertical that continues to grow at over 8 per cent every quarter, segments such as manufacturing (especially automotive and aerospace) and retail too have grown at a healthy clip, indicating a broad-based revival in client spends.

Telecom is the only vertical, as is the case for most majors, that has not revived significantly and continues to grow anaemically.

From a geographic perspective, while the revival with regard to US clients has been in place for four-five quarters now, the last couple of them have also seen increased offtake in Europe despite sovereign debt concerns there and in India.

Improvement in key metrics

Reflecting the recovery, volumes (person-months billed) have increased by over 20 per cent this fiscal. This has also been augmented by billing increases that Infosys has managed in recent times, especially from new contracts. This up-tick has meant that utilisation too touched new highs, at over 80 per cent.

The proportion of fixed-price contracts, that ensure higher realisations compared with ‘time & material' based ones, has steadily increased over the last four quarters and now accounts for over 40 per cent of revenues.

These facts suggest that, going forward, the company may also see steady profit growth, though it would take another three-four quarters to catch up with revenue expansion.

Client additions too have been robust with the recent quarter witnessing as many as 40 new ones being added.

Large-sized contracts ($100 million-plus) have also been coming thick and fast with over 11 such clients, five being added over the past year.

Even in the $50-100 million range, the company has witnessed sound traction in clients.

This suggests that transformational deals that ensure revenue visibility over many years are making a comeback. This, by itself, is welcome, though it would entail increased presence at the client's place and would thus escalate costs. In fact the onsite component has steadily increased in the last one year. This may also rise due to the political decisions taken by governments on offshoring.

While the company lags TCS in volume growth, the above factors may play out to ensure that it plays catch-up.

Risks

Attrition has increased by nearly 6 percentage points over the last one year, has touched 17.5 per cent levels, as the industry revives.

There would be significant risks to margins if any off-seasonal wage hikes are given to stem the tide. Infosys, which has the highest margins in the industry, still has some cushion on this front.

Although not immediately foreseen, any strengthening of the rupee and even the euro against the dollar could dent realisations.

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