The outlook for the global economy has turned weaker in the past month, what with oil prices hitting new highs and no signs of abatement in the subprime crisis. This has impacted software services companies in two ways. There have been delays by clients in giving out orders and the worst-hit customers have started renegotiating prices.
Under these circumstances, it seems commendable that Infosys Technologies Ltd has maintained the outlook on demand growth and pricing it gave three months ago. The company has left its dollar-based revenue and profit guidance unchanged, except for a 1 cent increase in the earnings-per-share target to reflect a tax reversal. The rupee-based guidance has been raised, thanks to the 7% depreciation in the local currency last quarter.
The markets, however, seem least impressed. Infosys shares fell 7% and the National Stock Exchange’s CNX IT index, which represents the sector, fell 6.5% after the results were announced. It’s interesting to note the index has dropped by 6.3% since April 23, when the rupee breached the 40-mark against the dollar and started its march towards the current 43 levels.
A 1% deprecation in the rupee leads to close to a 1.5% increase in operating profit, and one would have expected the market to be extremely excited about the 7% deprecation. After all, operating profit estimates would have to be revised upwards by about 10% just because of the rupee depreciation. A closer look at the chart shows that the CNX IT index did, at one point towards the end of May, rise by about 15% to reflect gains from the move in the rupee.
Although the rupee has marginally strengthened from May-end levels and have pretty much hovered around the 43-mark since, the IT index has lost 18% in value. What gives? The sharp correction is partly because IT stocks had run ahead of fundamentals; but in large part it’s because of a major shift in the market’s view on the demand and pricing scenario in the US.
Some comments made by the Infosys management in a conference call with analysts reinforce that view. Some of those comments were: “There have been some sporadic renegotiations with clients on pricing...”; “There have been delays in decision making in the banking and financial sector...”; “... All challenges are not over and we’re not sure how long this will last.”
While Infosys has maintained its fiscal 2009 guidance, some analysts are concerned what all this translates into, as far as their fiscal 2010 estimates go. According to one analyst, the pricing renegotiations may soon become non-sporadic and could impact fiscal 2010 estimates. The largest software firm in the country, Tata Consultancy Services Ltd, had said last quarter that it hadn’t billed some large clients during a project’s transition, which analysts said was as good as a discount. Infosys’ statements confirm fears of a slowdown at least as far as pricing goes. It must be noted that the firm’s management has reiterated that it isn’t seeing renegotiations as a trend, and at the company-level, pricing is stable.
But the mood the markets are in, investors would rather play it safe than sorry. Still, that’s not to say that the worst has been priced. Infosys trades at 20 times trailing earnings, at a time when earnings in dollar terms are expected to grow 17-19% this year. Unless news flow turns markedly positive, there’s still room for downside.
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