Infosys’ revenue and profit targets were known to be conservative at one time. The firm had earned this reputation having always beaten its targets by a wide margin. Between fiscal 2002-03 and 2007-08, it beat its annual dollar-based guidance by as much as 10 percentage points. In FY03, for instance, it reported $754 million (Rs3,770 crore today) in revenues, 15.3% higher than the target set at the beginning of that fiscal year.
This changed in the previous fiscal year. The firm had said revenues would grow by 19-21% at the beginning of the year, but ended up with a growth of only 11.7%. While some of this was because of volatile currency movements, the underperformance was largely owing to wrong assumptions on billing rates and volumes in the guidance. In the previous two quarters, the company has even missed the lower end of its revenue guidance in dollar terms, causing some analysts to conclude that Infosys no longer keeps a “buffer” in its guidance like it used to.
On the face of it, the firm’s guidance for fiscal 2009-10 seems conservative. Revenues are expected to drop by 3.1-6.7% and earnings are expected to fall by 11.1-15.1%. But the assumptions behind the guidance are far from being conservative. As the head of research at a domestic institutional broker points out, “The full-year guidance is aggressive based on the company’s assumptions on volumes, pricing and the level of the domestic currency.” Infosys’ chief financial officer V. Balakrishnan says: “Our guidance is realistic, based on our interaction with clients and the facts we see today.”
But hardly any analyst is buying that argument. The guidance for the June quarter is rather conservative, with revenues expected to drop by 3.7-5.4% sequentially in dollar terms, and profit expected to fall by as much as 16%. The research head says the targets set for June are likely to be beaten easily. The problem lies with the full-year guidance, which assumes a compounded quarterly average growth rate of 1.7-3% in revenues for the next three quarters. Considering that the outlook for IT spending remains challenging, this dependence on back-ended growth hasn’t gone down well with analysts tracking the stock.
The major problem with Infosys’ guidance, however, is not about assumptions on volumes, but on pricing. 60% of its clients have already had discussions with the firm relating to renegotiations on pricing. This has led to a 1.4% decline in average realizations in the December quarter and a 2% drop in the March quarter. The guidance assumes that average billing rates will remain where they were during the March quarter for the whole of FY10. The consensus on the Street is that pricing would continue to be under pressure in FY10, given the challenges most of Infosys’ clients are facing. The assumption that prices won’t fall from current levels is indeed aggressive.
Finally, the firm’s rupee guidance is based on the March-end rate of Rs50.7/dollar. The domestic currency has already appreciated by 2% to Rs49.7/dollar, which puts the rupee guidance at risk. Balakrishnan says he expects the rupee to depreciate in the short term owing to political uncertainty and the high fiscal deficit.
One lever IT firms have used to counter the impact of sluggish volumes and lower pricing is better utilization of manpower. Infosys’ manpower utilization, however, is expected to fall from last year’s levels of 67.3% to 62-63%. This is because while volumes are expected to be flat, the firm plans to hire 18,000 this year. Most of these candidates have already been sent appointment letters, which means there’s no room for cutting down on these costs. This is one of the main reasons for the expected drop of 300 basis points in the firm’s margins this year, apart from the expected drop in realizations.
Unless the situation in the US changes dramatically, there’s a high possibility that Infosys would miss its guidance again. This possibility doesn’t seem to be reflected in the stock price, which barely fell after the results were announced, thanks to the strong sentiment in the market. Other IT stocks seem to be in a worse position, having outperformed Infosys in the recent rally.
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