Infosys Ltd’s March quarter results announcement establishes that its better-than-expected performance in the December quarter was a flash in the pan. Revenues surprisingly fell 0.2% to $1,867.7 million (around Rs.10,160 crore today) in organic terms, i.e., excluding revenue added through the acquisition of consulting firm Lodestone Holding AG. Analysts at JPMorgan and Kotak Institutional Equities had estimated organic growth of 2.4% and 2.8%, respectively, for the March quarter, which shows the stark difference between Street expectations and the reality.
What’s more, the company has missed its organic revenue growth guidance of 5% for the full year. Excluding Lodestone, revenue grew just 4.2% in fiscal 2012-13. Infosys said on a call with analysts that it has experienced delays in the ramp-up of projects. This is visible in the near 1% drop in its offshore revenue.
The company’s guidance for fiscal 2014 (FY14) shows that it doesn’t expect things to improve in a hurry either. Infosys expects revenue to grow between 6% and 10% in FY14, and the lower end of its guidance is substantially below Nasscom’s IT (information technology) exports revenue growth target of 12-14%. The Lodestone acquisition will add about 2% to revenue, which means Infosys expects organic revenue growth of only 4-8%. Excluding FY10, when the impact of the financial crisis was at its peak on the IT industry, this is the weakest guidance in the company’s history. Chief executive officer S.D. Shibulal has suggested that the company’s growth is lagging behind peers because it gets a much larger portion of revenue from customers’ discretionary spends, and that this segment hasn’t recovered.
Worse still, margins are expected to be under stress because of pricing pressure. Infosys said in an earnings call that a large part of its business was facing pricing pressure. Average billing rates fell 4% in FY13 over FY12 excluding Lodestone. Apart from the strain on pricing, the company has to absorb increased employee costs, due to wage hikes given earlier this year, and acquisition-related write-offs and expenses. If margins shrink at the same rate they did in FY13, operating profit could fall between 3.5% and 6.3% next year in dollar terms. In FY13, operating profit fell 5.2% to $1,909 million.
There is little doubt that Infosys is to blame for missing its own guidance and lagging behind peers by a significant margin. But investors have themselves to blame for the sharp 20% correction in the company’s value. The 25% jump in its shares since the December quarter results announcement was clearly overdone.
While the third quarter (Q3) results were impressive, there were signs that growth may not be sustained. For instance, sequential volume growth was just 1.5% in Q3. And growth was helped by unusually high growth in the India business (up 17%), business process outsourcing (up 12.9%) as well as the Finacle business (up 7%). Pointing out all of this in a call with analysts, chief financial officer Rajiv Bansal had said, “If you look at it, challenges remain because volume growth is 1.5%; (a 1.8% increase in) pricing helped us. As we go into Q4, challenges remain.”
Even now, after the sharp drop in the stock, valuations aren’t cheap at 14.5 times trailing earnings, especially given the possibility of a second consecutive year of a decline in operating profit. Other top-tier IT stocks were pretty resilient, except Wipro Ltd, which fell around 5%. But investors now need to question the relatively high valuations of all IT stocks. IT valuations have been sustained at high levels because of the lack of alternatives in the domestic market. Infosys’s results indicate that the sector is no safe haven. While it’s true that it is facing company-specific issues, it’s naïve to assume that the rest of the industry is doing fine, especially after a string of disappointing results from companies such as Accenture Plc and Oracle Corp. last month..