Is Infosys being overly conservative with its guidance?
Infosys Ltd’s revenue and profit growth in the September quarter were miles ahead of the Street’s estimates. Revenue grew by 3.9% in constant currency terms sequentially, far higher than the mere 1% growth Tata Consultancy Services Ltd reported on Thursday. And while TCS’s operating profit rose 4%, Infosys’s profit rose 7%.
Still, TCS shares rose 1.8% on Friday, while Infosys shares fell by around 2.5%. While the rise in TCS’s shares is beyond comprehension, in Infosys’s case, investors seem to be worried about the cut in the revenue growth forecast. The firm said it now expects revenues to grow between 8% and 9% this fiscal. This implies growth will fall from 10.5% in the first half of the year to around 6.5% in the second half, assuming the company ends up at the mid-point of its guidance range.
But investors needn’t be too worried; Infosys is being conservative after having had to revise its guidance two quarters in a row. “After all, which company would want the ignominy of revising its guidance downward for three consecutive quarters?” points out an analyst with a domestic institutional brokerage. The current guidance appears to include a buffer in case the macroeconomic environment turns worse. Note that analysts had already factored in a drop in growth rates because of the multiple challenges the industry is currently facing.
Analysts at Kotak Institutional Equities said in a 3 October note to clients, “Up until now, Infosys’s approach has been to guide on the basis of the way it sees the demand environment and does not normally include a cushion for macroeconomic shocks... If the company continues with its historical approach, then the guidance will be cut to 9-10% range (from 10.5-12% earlier). However, the cut could be higher if the company wants to build in an additional cushion.”
Even if revenues are flat in the remaining two quarters, the firm will end up with a growth of 9% for the year. While things have deteriorated for the industry, it’s a bit much to expect such a dire scenario based on current trends. Infosys continues to win large contracts and said it has a healthy pipeline of contracts. The heads of its banking, financial services and insurance and retail verticals said on a call with analysts that thanks to its strong competitive positioning, it has gained market share in the first two quarters of the year. They added that with the new capabilities the company has acquired, Infosys will continue to capture market share. This commentary is clearly at odds with the sombre revenue growth forecast.
Note also that in the past 12 months, Infosys’s volumes grew by a healthy 13.2%. While this is lower than the near-term peak of 14.5% in the 12 months till March 2016, it’s not as if growth has fallen off a cliff. Besides, while pricing was under considerable pressure in FY16 and fell by nearly 5%, the sequential decline has ebbed this fiscal.
The upshot: Infosys has more or less maintained the lead it acquired against TCS last year. On a year-on-year basis, revenue grew 8.9% in constant currency terms last quarter, compared with the 7% growth for TCS.
Based on its Q2 performance, it’s clear Infosys continues to have momentum on its side, which has helped it outpace its larger competitor. “We back Infosys given it is gaining share in large deals and wallets of large clients, and is positioned well to capture discretionary spends. Near-term volatility and risks to guidance aside, Infosys is making right investments in automation and digital for sustained profitable growth over the next few years,” Kotak’s analysts added in their note to clients.