Infosys Q2: Cut in FY18 guidance underlines growth challenge
Investors began hedging their bets on Tuesday even before Infosys Ltd released its results. The stock lost 1.6% compared to a 0.2% increase in the Nifty. The results, declared after markets closed, validated investors’ fears, as the company cut its guidance. Its fiscal year 2018 (FY18) revenue growth guidance stands revised down to 5.5% from 6.5% at the lower end of the guidance range, and down to 6.5% from 8.5% at the higher end.
Many analysts were expecting Infosys to reduce its revenue growth guidance, so this was not a complete surprise. But expectations were tilted towards a lowering at the higher end. “A cut in lower-end guidance would be taken negatively, in our view,” Nomura had said in an earnings preview report.
The guidance cut comes on the back of subdued earnings performances by Wipro Ltd and Tata Consultancy Services Ltd (TCS). Further, it strengthens the belief among several analysts that Indian IT firms are facing structural growth headwinds, and recovery can be a long-drawn process.
“The three big companies which have released their September quarter results till now have not indicated any acceleration in growth rates in the second half of the year,” says Girish Pai, head of research (institutional equities) and IT services analyst at Nirmal Bang. “At the aggregate level, we see organic revenue growth of 5-7% in FY18 for large (tier I) IT companies in India.”
Now, Infosys’s constant currency revenue growth of 2.2% sequentially is largely in line with Street estimates. Against the expectation of a reduction in profitability, it managed to improve margins, thanks to better efficiencies and utilization levels. It maintained the operating margin guidance at 23-25% for the full year and indicated growing traction of new services (includes digital, cloud services among others).
But as in the case of its larger peer TCS, the new (and fast- growing) services segment is relatively small compared to the traditional business, to make a difference to overall growth. New services’ contribution to Infosys’s revenues stood at 9.4% in the September quarter.
Revenues from North America, geographically a large business area, increased 1.9% in constant currency terms, below the company average. Encouragingly, financial services, which generates a third of the revenues, registered above (the company’s) average growth. But manufacturing and retail, which together generate about 44% of the company’s revenues, lagged.
According to the management, barring retail, the company is seeing recovery in all business verticals. But the reduction in its revenue growth guidance indicates that recovery could be a long-drawn process. Infosys expects seasonal weakness in the second half due to holidays and year-end budget issues. While business optimism is returning in the core financial services vertical, there is no clarity on budgets and spends.
While the company commentary on the business outlook is positive, its confidence to convert this to revenue growth seems less so, especially in the near term. While the uncertainty caused by Infosys’s leadership problems is behind it, the onus is on the new management to deliver.
A lowered guidance is a disappointment but also takes some pressure off the new management. If they can deliver this or better still exceed it, that can put investors back in a good mood.