Infosys Technologies Ltd has revised its earnings guidance for financial year 2007-08 downward by about 4% (to Rs77.31-78.11), almost exactly in line with street expectations of a 3-5% drop. But Infosys shares fell 4.5% despite the fact that a downward revision was already factored in its share price (See Mark to Market dated 11 July).
So what gives? The markets had assumed that much of the impact of the appreciating rupee would be offset by strong demand growth, which, according to analysts, had picked up since the time the company had given its previous guidance in April. But Infosys hasn’t factored in any pick-up in demand. Based on its April guidance, dollar revenues were expected to grow between 25.4% and 28.1% in the nine-month period between July and December. Its current guidance assumes growth between 26.4% and 28.5% for the same period. That’s an upward revision of 1% at the most, which again is accounted for by the 1% increase in average price realizations in the past quarter. What’s more, the company won three large orders (in the region of $50 million) in the June quarter. This wasn’t factored in the guidance in April, but has been now.
The only reason Infosys’ revised EPS was in line with market expectations is that other income is now expected to be much higher. And surprisingly, this is not because of gains from hedging forex risk. Last quarter, other income rose 112% to Rs253 crore, but less than 30% of this amount came from forex-related gains. Rs182 crore came from interest income, which jumped 250% over last year’s levels. In fact, interest income stood at Rs192 crore for the whole of FY07. Infosys’ cash and cash equivalents have jumped 88% over last year’s levels to Rs6,442 crore, and yields too have risen considerably. This source of income alone would add about Rs10 to Infy’s EPS.
Coming to the June quarter results, Infosys managed to meet its earnings target although revenues were below estimates because of the rupee. The impact of rupee appreciation (11% y-o-y) and wage increases was also managed well. The rupee’s rise alone should have hit margins by about 500 basis points (bps), but the company reported a y-o-y drop of just 106 basis points. The reason: Price realizations have risen considerably over the past year. Infosys has been saying for some time that billing rates have been stable with an upward bias. Last quarter, onsite and offshore realizations rose 6.7% and 5.3%, respectively, the highest y-o-y increase in recent times for both segments.
If one were to assume a similar increase in pricing for the rest of the three quarters, Infosys’ volume growth guidance looks unduly conservative at around 23%. (Volumes had grown over 32% in the June quarter.) But pricing may not increase by the same margin in all three quarters, since the base had increased considerably in the third and fourth quarters of FY07.
This leaves two other factors which can cause Infosys to beat its FY08 guidance by a substantial margin—a depreciation in the rupee, which few people are betting on at this point, and an increase in volume growth. But even then, it would be tough to beat consensus estimates, which are about 6% higher than Infosys’ guidance estimates.
This, coupled with its muted stance on volume growth, would cause Infosys’ share price to continue underperforming the market in the near term. Despite the fall in share price post-results, Infosys trades at 27 times trailing 12-month earnings, or 1.6 times estimated earnings growth this year.