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Business News/ Market / Mark-to-market/  Q2 results: At Infosys, growth is coming at a high cost
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Q2 results: At Infosys, growth is coming at a high cost

Since Infosys still lags TCS by a wide margin in terms of revenue growth, the strategy to sacrifice margins for growth may be a sensible one

While TCS’s growth pickup was accompanied by a rise in margins to a 14-year high, Infosys’s higher growth has led to pressure on margins, which are at a 20-quarter low. Graphic: MintPremium
While TCS’s growth pickup was accompanied by a rise in margins to a 14-year high, Infosys’s higher growth has led to pressure on margins, which are at a 20-quarter low. Graphic: Mint

First, the good news: Infosys Ltd’s revenue growth in the September quarter (Q2) was its highest in the past eight quarters. In constant currency terms, i.e. after eliminating the impact of exchange rate fluctuations, revenues grew 8.1% year-on-year in Q2, much better than the average growth of 5-6% in the preceding four quarters. Now, the bad news: the company’s operating profit margin is at a 20-quarter low. And although the rupee has depreciated by over 11% in the past six months, Infosys is continuing to guide for margins of between 22 %and 24% for the full year, the same levels it had forecasted back in April.

This is not how things were supposed to go. The sharp depreciation in the rupee was expected to boost profit margins at least in the near term. Last week, the company’s chief competitor, Tata Consultancy Services Ltd (TCS), reported a 150 basis points improvement in margins sequentially. Its margins reached a 14-quarter high, boosted by the decline in the rupee.

Infosys, on the other hand, has been forced to hand over the gains from the currency to employees and sub-contractors, to support growth and rein in employee attrition. In the second half of the year, the company plans to step up investments to capitalize on opportunities in digital services, which will put a lid on margins as well.

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Since Infosys still lags TCS by a wide margin in terms of revenue growth, the strategy to sacrifice margins for growth may be a sensible one, unless it has struck large deals that entail low margins for some time to come. The company’s revenues were considerably ahead of the Street’s estimates. Besides, it announced deal wins worth over $2 billion, the highest ever for a single quarter, and nearly double the levels it reported in Q1. While this is nothing to sneeze at, the fact remains that expectations have been running high with IT stocks, including Infosys, which has outperformed the Nifty 500 index by about 40% this year.

In that backdrop, investors will be disappointed that the higher-than-expected increase in revenue growth is not translating into higher earnings growth. Infosys’s net profit grew by 10.3% year-on-year in Q2, less than half the rate at which TCS’s net profit rose.

Of course, one can argue that Infosys also trades at a lower price-earnings multiple of 19 times estimated FY19 earnings, compared to TCS’s valuation of 23 times earnings. But given the large differential in earnings growth rates between the two companies, investors now need to consider if the valuation discount is wide enough.

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Published: 17 Oct 2018, 07:25 AM IST
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