Infosys Ltd shares fell 5.5% on Friday, making it the fourth successive quarter in which its shares have fallen sharply after a results announcement. While there is little doubt that the company is struggling, investors are equally to blame for the sharp drop in the share price.
Infosys shares had recovered all of the losses since the disastrous June quarter earnings announcement, outperforming shares of Tata Consultancy Services Ltd in the process. A number of analysts were expecting the company to grow revenue by 4% in the September quarter. But, as it turns out, it was foolhardy to expect such a quick revival. The company reported a mere 2.6% growth in revenue. Adjusted for a one-time write-off it took in the June quarter, underlying revenue growth is merely 1.7%.
To meet the annual growth target of 5%, the asking growth rate for the December and March quarters has now risen to 3.7%. If the company had managed to grow revenue by 4%, as some analysts were expecting, the asking growth rate would have been only 2.1%. Considering that Infosys has managed a mere 1.7% growth in a seasonally strong quarter, it will clearly be a challenge to increase growth rates by 2 percentage points in a relatively lean period. The December quarter is affected by a relatively higher number of non-working days, while in the March quarter, demand eases off a bit owing to the uncertainty related to the clients’ new budget cycle. According to the company, its recent large deal wins will support growth in the coming quarters. However, as one analyst pointed out in a conference call with the management, history doesn’t support a higher growth rate in the second half of the year relative to the first half. In other words, it will be a challenge to even meet the seemingly weak 5% growth guidance.
And while revenue growth remains challenging, the company’s pricing strategy and its impact on margins is increasingly becoming a worry. Adjusted for the one-time write-off in the June quarter, profit margins fell by more than 200 basis points (bps) last quarter. A basis point is one-hundredth of a percentage point. This was despite an improvement in employee utilization, a 4% increase in volumes, and the fact the average rupee-dollar rate was flat quarter-on-quarter. According to Infosys, the key reasons for this are an increase in costs related to hiring sub-contractors as well as additional provisions for post-sales client support. The increase in these two expense items amounts to a 100 bps hit, which still leaves a large part of the impact unexplained.
It does look like Infosys is getting increasingly flexible with its pricing and is now willing to sacrifice margins to win market share. On a year-on-year basis, average price realization in the company’s offshore segment fell 7.2%. In the June quarter, offshore price realization had dropped by 3.1%. In the first six months of this fiscal year, its average price realization for both onsite and offshore work has fallen by nearly 5%. According to the company, though, pricing has been and remains stable.
Infosys will continue to face headwinds as far as profitability is concerned. While the rupee has appreciated recently, the company also has to absorb wage hikes in the second half of the year. Needless to say, earnings estimates will get downgraded after the miss in the September quarter. In this backdrop, it’s surprising that Infosys shares found a floor close to the Rs.2,400 mark on Friday. In the first six months, revenue and operating profit have growth by less than 4% year-on-year, hardly justifying the mid-teen valuation multiples the company continues to enjoy. Since there are hardly any signs of growth picking up meaningfully, it’s quite likely the stock will now drift lower.