For the first time ever, Infosys Technologies Ltd reported annual revenues and profits that were lower than the targets it had set a year ago. But it’s also the first time the rupee appreciated as much as 11% in a year. In dollar terms, the firm beat its year-ago guidance by a decent margin. The rupee may not appreciate as much this fiscal year, but Infosys is faced with other, newer challenges including a likely recession in the US, which accounts for 62% of its revenues. Concerns that the situation in the US would impact both volumes and pricing had led to a massive underperformance in Infosys’ shares. Surveys of analysts tracking the firm also suggested expectations were running low.
Given this backdrop, Infosys’ revenue growth target of 19-21% and earnings growth target of 16-18% came as a welcome relief to investors in IT stocks. The targets were at the higher end of most analysts’ expectations. Not that the company is oblivious to the near-term concerns in the US market. In the June quarter, it expects revenues to stay where they were in the previous quarter and it has forecast earnings would drop?on a quarter-on-quarter basis owing to salary hikes and visa costs, which bunch up in the first quarter.
Growth Slows (Graphic)
That also implies growth in the remaining quarters would be exceptionally high. In dollar terms, revenues must grow at 6.6% and earnings by 8.3% on a quarter-on-quarter basis in each of the remaining three quarters. Note that revenue has grown at an average rate of 5.7% in the preceding two quarters and is expected to remain flat in the June quarter. The pertinent question, then, is whether Infosys’ target is realistic and achievable?
Well, going by the stock market’s reaction to Infosys’ results, the answer is yes. The stock gained by 6.2% on Tuesday and lifted the shares of most of the company’s peers by an equal measure. Still, a number of analysts are questioning the basis for Infosys’ confidence for the rest of the year. After all, if concerns about the US economy caused it to project flat revenues in the June quarter, shouldn’t the uncertainty have led to a similar outlook for the remaining quarters?
According to chief financial officer,V. Balakrishnan, “Our clients have suggested that they have taken stock of the pain in the system and are now more comfortable about their IT spending plans than they were about a month ago. Their feedback suggests that their IT spend would be back-ended (i.e. higher in the second half of the year). Our guidance is based on data we have collected from them.” The guidance is based on feedback from its top 100 clients, which together account for 83% of revenues. About three-quarters of them have said that they plan to either cut their IT budgets or at best keep it flat. But almost all of the 100 clients surveyed have said that they will increase the proportion of work done offshore, which has led to the company’s confidence.
The company’s management has emphasized that they see little risk to pricing this fiscal year.
Balakrishnan says the probability of billing rates falling from current levels is lower than that of prices rising. The guidance, by the way, assumes pricing will remain flat at the March quarter levels. The main concern, according to the management, is that of volume growth being lower than anticipated.
Still, not all analysts are convinced. A fund manager at a domestic mutual fund points out there are other risks such as a further appreciation in the rupee and a drop in billing rates. Most clients have either cut IT budgets or have kept them flat—they would necessarily aim to extract the highest value. One way to do this is to increase the proportion of offshore spend—which Infosys is banking on—while the other is to simply demand a reduction in billing rates. The last time US went into recession, billing rates fell sharply. The fall may not be as sharp this time around, as offshoring has gained much more acceptance compared with financial year 2001-02 when that happened, but a decline cannot be ruled out.
Also, most brokerages expect the rupee to appreciate this fiscal year to about Rs36-38 (Infosys begs to differ), which could put pressure on the company to achieve its growth targets, which are based on an exchange rate of Rs40 to the dollar.
The Infosys stock trades at 19 times trailing earnings, while earnings are expected to grow by 18% this fiscal year. Growth could be in single digits the year after, thanks to a near 50% jump in tax provisions, as exemptions related to software technology parks will expire. That doesn’t leave much on the table as far as valuations go. On the contrary, if one expects negative news flow to continue from the US, the stock could be seen as more than fully priced. A positive for investors, nevertheless, is that the company has modified its stance on dividend payouts, which helps immensely since a large pile of idle cash on its books was earning suboptimal returns for the company’s investors.
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