Infosys Technologies Ltd’s guidance for the year ending March had seemed a tad aggressive in April. This was owing to the underlying assumption that pricing would remain at the same levels as in the January-March 2009 quarter. Besides, the rupee/dollar rate was assumed at the March-end close of 50.7. The rupee, of course, appreciated by 5.5% in the June quarter and the company has now had to cut the higher end of its earnings per share target by about 5% to Rs 96.
But leave aside currency movements, the underlying business is doing much better than anticipated, and the annual guidance now seems overtly conservative. In the June quarter, the company beat its dollar-based revenue target by about 3%, even after adjusting for the favourable impact of the US dollar’s depreciation against the euro and the pound. Volumes declined by only 1% quarter-on-quarter, despite a fall of at least 20% in billing by its top client. If it weren’t for the drop in business from the top client, volumes would have risen in the June quarter.
The company’s chief executive, S. Gopalakrishnan, told analysts in a conference call that Infosys has been able to retain its clients across industry verticals and across geographies. It has also helped that hardly any of its clients have filed for bankruptcy. Most analysts had assumed that volumes would decline by 2% or more in the June quarter, and so the growth in volumes (excluding the top client) is a pleasant surprise.
In constant currency terms, average pricing declined by only 1% last quarter, again, a positive surprise.
Thanks to the higher-than-expected revenue in the June quarter, Infosys needs to grow revenues by just 0.25% sequentially for the next three quarters to meet the higher end of its dollar-based revenue guidance. In April, its guidance had assumed a sequential growth of 3% in the latter three quarters of the year.
Why is Infosys being so conservative? Gopalakrishnan told analysts repeatedly on the call that they’d prefer to be cautious in the current environment, as things are still unpredictable. According to him, it’s too early to say that the global economic situation has improved, with recent US data on unemployment and credit card defaults causing some concern. Besides, while most of its clients have already completed renegotiations on pricing for the year, they have reserved the right to come back for further price cuts if the economic situation worsens.
Consensus estimates of the company’s earnings this year are way higher than the guidance estimates. Ahmed Raza Khan / Mint
Most analysts, though, feel that the company will easily beat its annual dollar-based guidance, especially after the performance in the June quarter and also considering the depreciation in the dollar in recent months. In fact, consensus estimates of the company’s earnings this year are way higher than the guidance estimates. The rise in Infosys’ shares on Friday, too, suggests that the markets haven’t taken the management’s cautious statements too seriously, but have instead focused on the positive takeaways from the June quarter results.
Apart from the better-than- anticipated revenues, there were other significant positive surprises in the quarterly results. Operating margin improved by about 57 basis points despite the marginal drop in volumes and pricing, and notwithstanding the appreciation of the rupee. The company managed this by aggressively cutting costs—primarily those related to employees. Staff costs fell by 63 basis points, thanks primarily to a reduction in the employee base. According to the head of research at a domestic brokerage, Infosys is aggressively letting go of people, as is evidenced by the net reduction of over 1,000 software professionals last quarter. According to the management, though, the involuntary attrition last quarter is a one-time affair, based on an annual evaluation process.
Free cash flow rose by 68% on a year-on-year basis, double the rate at which pre-tax profit grew, thanks mainly to a reduction in debtor days.
Infosys’ June quarter results, therefore, demonstrate an all-round performance, with the firm managing its client base well, containing costs and improving cash flow. The only negative surprise was the jump in effective tax rate to about 20%, from 17% earlier. The worrying part is that this isn’t one-off and the tax rate for the whole year is expected to be around the same levels as in the first quarter. In fiscal year 2010-11, the tax rate could go up to 24-25%, according to chief financial officer V. Balakrishnan. These are much higher rates than what the markets had been factoring in. The company’s strong execution in the June quarter has, of course, overshadowed the surprise on the tax front.
Infosys’ results have reaffirmed the markets’ position that things have improved considerably for the IT industry in the past few months. But investors need to perhaps give some more weight to the management’s commentary and exercise some caution before extrapolating the results for the next few quarters as well.