While the broad markets have been sluggish since the Nifty hit an all-time high in early November, investors in information technology (IT) stocks have done very well. The National Stock Exchange’s CNX IT index outperformed the Nifty by around 18% between early November and 12 January, just before Infosys Technologies Ltd announced results for the December quarter. Put differently, expectations from Infosys and the IT sector were running very high.
In fact, since late December, there have been a number of target price upgrades for the Infosys stock by analysts at large brokerages. According to Bloomberg data, Kotak Institutional Equities raised its target price by 12% to Rs 3,800 per share; HSBC raised it by 20% to Rs 3,830; CLSA by 11% to Rs 3,875 and Nomura by 12% to Rs 3,580. The upgrades picked up momentum about a week ago, with about four institutional brokers, including Credit Suisse, raising their target price above Rs 4,000 per share. Earlier this week, Goldman Sachs raised its target price on the stock by 27% to Rs 3,820.
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It’s a little unusual to have such large-scale upgrades just before the company’s results announcement. Analysts typically wait for the results announcement before tweaking earnings estimates and target prices. It almost looks as if brokerages were compelled to keep up with the sharp rise in Infosys’ share price. But what’s even more disconcerting about some of the latest upgrades is that they assume earnings growth of 28-30% for the next two fiscal years.
With such high expectations, the markets had essentially set themselves up for disappointment. Infosys had hardly any room for error. In that backdrop, the company’s reported volume growth of 3.1% in the IT services business comes as a huge negative. What’s more, the company expects revenue growth of between 1% and 2% in dollar terms in the March quarter. Of course, as it typically does, it should beat this guidance; but the Q4 guidance is weak even by Infosys standards.
This sort of anaemic growth for two successive quarters is, needless to say, difficult for investors to digest, especially considering that the company was being valued at around 28 times estimated FY11 earnings. It’s little wonder then that Infosys’ shares fell by over 5% after the results were announced.
Infosys’ December quarter results were not weak—in fact, the company did better than its guidance. Thanks to an improvement in pricing and cross currency benefits, revenue grew by 6% in dollar terms and margins were maintained despite a 3.5% appreciation in the rupee and a drop in employee utilization.
The problem, therefore, isn’t as much with the company’s performance as it is with Street expectations. Most analysts have a rose-tinted view of the future. The Infosys management, meanwhile, still feels that the macro-environment warrants cautious optimism. Chief financial officer V. Balakrishnan says that there is still a lot of uncertainty in the global economy and that this is reflected in client spending behaviour. IT services customers, he says, aren’t commissioning long-term projects—most of the IT spend is on short-term projects. This is to ensure that if the economic situation worsens, they aren’t left with expenses that are long-term in nature.
At the same time, clients’ IT budgets for 2011 are either flat or marginally up compared with the previous year. Besides, the allocation for offshore work is expected to rise. So there is reason for optimism as well. Given the high target prices set by many brokerages, it’s highly likely that the latter statements will be given more weight. In that case, one would have to wait for another results announcement for the next reality check.
Graphic by Yogesh Kumar/Mint
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