Infosys Ltd has lagged peers on revenue and profit growth in six of the past seven years. But even when its competitive position rapidly deteriorated, it held on to the pole position for one important metric—cash flow generation.
In the past seven years, cash flow from operations amounted to 23.3% of revenues for Infosys, compared to 19.8% in the case of Tata Consultancy Services Ltd (TCS) and 16.2% for Cognizant Technology Solutions Corp. But, as is well known, Infosys has lagged considerably in terms of shareholder returns during this period. Cash may be king, but it is clearly no emperor. Investors far prefer strong growth accompanied by a reasonable amount of cash generation to exceptional cash generation accompanied by sluggish growth.
Is TCS now falling into the same trap? Its growth rate has fallen considerably and cash flow generation has improved in recent years. It has closed the gap with Infosys considerably in terms of cash generated from operations—19.3% of revenues in FY16 versus 19.6% for Infosys. Besides, it has curtailed capital expenditure. As a result, it has overtaken Infosys in free cash flow generation in the past two years. The amount spent by TCS on capital expenditure and acquisitions accounted for just 12.5% of cash flow from operations in the past two years, compared to 28.7% in the case of Infosys.
Should investors be worried? According to an analyst with a multinational brokerage firm, the company has chosen the organic route to invest for the future, compared to some of its peers who have preferred acquisitions to plug gaps in their portfolio. Analysts at JPMorgan India Pvt. Ltd said in note to clients after attending an 18 March analysts’ meet, “We came away with an enhanced appreciation of TCS’s digital capabilities and conclude that its lack of M&A in digital does not necessarily mean lack of capability—it is strongly building the needed, differentiating digital strengths organically.”
Another reason cash flow generation has improved in recent years is that the company has reduced its exposure to some emerging markets such as India. Working capital needs are typically higher in these regions, and the lower exposure has meant that overall cash generation has improved. Both of the above points suggest that growth isn’t necessarily being sacrificed. Of course, it remains to be seen if TCS’s plan to grow organically helps it catch up with peers soon.
Thankfully for Infosys’s shareholders, its new leadership has made growth a priority. The company even beat TCS on revenue growth in fiscal year 2015-16. M&A (mergers and acquisitions) activity has picked up, indicating that it is getting bolder with its use of cash. And cash flow from operations fell to below 20% of revenues last year, compared to around 24% in the preceding three years. Perhaps TCS too needs to take a cue and loosen its purse strings to position itself better for growth ahead.
The writer does not own shares in the above-mentioned companies.