Infosys: Bleak prospects

Volume and pricing decline in Q4FY12 unexpected: Infosys registered blended volume decline of 1.5% q-o-q (1.2% in Offshore and 2.1% in Onshore) after registering a 3.1% increase in volume last quarter. Infosys reported a 40bp q-o-q (quarter-on -quarter) decline in onsite pricing and 180bp q-o-q decline in offshore pricing. Blended pricing has declined by 130bps (vs. up 80bps q-o-q in Q3).

Utilisation and attrition decline: The company reported utilisation dip by 570bps to 70.7% (vs 76.4% in Q3). The LTM (last twelve months) attrition also reduced to 14.7%,down 70bps from the 15.4% reported last quarter. Gross hiring came in at 10.7k for the quarter (vs 9.6k in Q3). The total headcount of the company stands at 150k at the end of FY12.

Q1FY13 and FY13 revenue guidance analysis: Infosys has guided to FY13 consolidated revenues of $7.5bn-$7.7bn,implying a 8%-10% revenue growth rate. To put this in context,the range for guidance expectations on the street before the results ranged from 9-15% $ revenue growth in FY13. The revenue guidance for Q1FY13 is $1.77bn-$1.79bn,with high end of the guidance implying a 1% sequential growth. To meet the top end of its full year revenue guidance Infosys would need to grow at CQGR (compound quarterly growth rate) of 5%.

FY13 Guidance below Nasscom guidance: The company’s US$ revenue growth and EPS guidance for FY13 stands at 8%-10% and R161 at the high end. This is under US$-INR currency assumption of R50.88 for the year. Q1 revenue growth guidance is 1% on the higher end.

The guidance trajectory: mapping the past: Infosys guidance history has been driven by macro fundamentals. We tabulate the guidance trend and actual performance by the company for the last six years. We would highlight that no set pattern emerges from the historical guidance pattern. In fact,it is driven by the larger macro economic factors,in our view.

Hiring guidance backs lower growth guidance: FY13e hiring target is lower than FY12. Infosys has a hiring target for gross addition of 35,000 for FY13. When we compare the guidance given in Q4 results and the actual year-end hiring number,there have been instances of upside in the past. We believe this should further indicate the strength of the deal pipeline with the company.

Impact

Is Infosys FY13 guidance conservative? We do not think that Infosys mgmt is building in extra caution while guiding for 8-10% US$ revenue growth next year. Given the delay in new project launches seen by Infosys in March,we think a significant beat on Q1 guidance is difficult. This implies the CQGR ask rate for the remaining three quarters to meet the 10% growth target would be 5%. With a fluid macro environment and the company facing a slowdown in its largest vertical,chances of beating the 5% CQGR are slim,in our view.

Global tech results and Infy guidance—the disconnect: The CEO mentioned on the call that higher share of discretionary revenues makes the comparison vs. other Indian vendors tough. While the Infy client portfolio is slightly more skewed to discretionary services,the data point on new software licence sales from software vendors and Accenture consulting order guidance indicate stable discretionary spend scenario.

Estimate changes: We now forecast 9% US$ revenue growth for FY13 (vs. 12.5% earlier). Infosys has guided for 50-100bps margin decline,largely on account of lower utilisation in FY13. The decision to keep wages flat provides a margin cushion to the company. This,coupled with weak INR (forex estimates unchanged) should restrict margin erosion to 20bps,in our view.

Sector implications: Sequential decline at the BFSI ((banking,financial services and insurance) vertical and North American geo were the key Q4 disappointments and cast worries on vendors with exposure to this vertical/geo. Our understanding from the Infy earnings call was that it’s possible other vendors addressing different portfolios at the same client might have not been affected by the ramp downs. Definite proof of this is likely in the results from other vendors over next two weeks.

Earnings and target price revision: We have decreased our INR revenue estimates by 4% for FY13 and 5% for FY14. This follows from our reduced US$ revenue growth forecast. We think the ramp down seen at BFSI clients in March is going to weigh on the company’s performance.

In Ebitda margin,we believe our revised margin assumptions adequately capture the benefits arising from a depreciated rupee.

In EPS,factoring in all the above changes and slightly higher tax rates,our new EPS estimates for FY13 and FY14 are R165 and R178,respectively.

We have reduced our FY13/FY14 EPS by 4%.

Our target price for Infosys is based on a three-stage DCF (discounted cash flow) model. We have factored in a 10% FCF (future cash flow) CAGR over a seven-year period (FY14-21) for the second stage of our DCF. Our terminal growth assumption is 5% and we have used a WACC (weighted average cost of capital) of 12.5%. We expect consistent volume growth and margin execution to drive the stock close to our target price. At our target price,the stock would trade at 15x FY13e earnings,which is lower than the historical average

We do not think the 12% sell-off is overdone and rate the stock Neutral. Investors looking to shift weight should consider TCS and Wipro,in that order.

—Macquarie