Why Infosys's best wasn't good enough for investors

Infosys Ltd’s September quarter results were its best in four years. In fact, it has done so well this could well be the first time in six years that it beats Tata Consultancy Services Ltd (TCS) in terms of year-on-year revenue growth.

Adjusted for one-offs, dollar revenues grew by 5% sequentially, higher than analysts’ expectations of 3.5-4% growth. On a year-on-year basis, revenues grew by 7.6%, higher than 5.7% growth in the June quarter. TCS is expected to grow dollar revenues by 6.3%, based on estimates of leading brokerages.

In any case, Infosys looks like it’s set to return to industry growth rates this year. Adjusted for currency fluctuations, growth in the past two quarters has been 10.9% and 13.1%, respectively. Nasscom’s industry’s growth target for FY16 stands at 12-14%. What’s more, the jump in growth hasn’t come at the cost of margins—earnings before interest and tax rose sharply to ₹ 3,993 crore in the September quarter, far higher than analysts’ estimates of a profit of around ₹ 3,800 crore.

All this should have got investors excited. But Infosys poured cold water on their hopes by sticking with its April guidance of 10-12% growth for fiscal year 2015-16. Effectively, this means it expects revenues in the next two quarters to remain flat at best or even fall by around 2% from second quarter levels.

Analysts at JPMorgan had said in a pre-results note to clients, “The March quarter has tended to be rather soft for Infosys, undoing the efforts of the year, besides serving as a weak exit rate going into the next year. In three of the last four years, Infosys registered negative growth (or declines) in constant currency revenue performance in 4Q.” The guidance suggests that the company expects this fiscal year’s January-March quarter to be soft as well.

Infosys chief executive Vishal Sikka said in a conference call with analysts that while Infosys’s endeavour is to buck the trend of the past years, it doesn’t have the required visibility to raise the guidance. The second half has a lower number of working days, and some companies take furloughs, resulting in lower growth. Even so, most large companies grow revenues at low single-digits during this period.

Infosys’s muted guidance of flat revenues has led investors to conclude that the company’s turnaround is far from complete. The wait for the return to industry growth rates continues.

Still, there’s much to like in the company’s performance so far this year. Growth was broad-based—all the verticals and geographies that the company is present in reported impressive growth. Besides, the company’s net addition of 8,453 employees was the highest ever, according to analysts at JPMorgan, pointing to confidence about future growth.

Volume growth stood at 3.7%, more or less in line with the Street’s estimate of revenue growth. The revenue beat came primarily because of a surprise increase in average price realisation. The word on the Street has been that Infosys is gaining volumes because of aggressive pricing; in that backdrop, the increase in realizations is heartening. One point of concern is the 33% drop in free cash flow generation in the first six months of the year, despite a 16.7% growth in operating profit.

But for a company that has lagged peers on growth for so many years, some compromise on profit margins and cash flow generation should be acceptable.

All told, Infosys has delivered stellar results for two quarters in succession and has almost put to rest worries about growth. The new management has also arrested high employee attrition rates and its hiring suggests optimism.

Nevertheless, the soft guidance has been a bit of a dampener. Infosys shares fell by 3.8% on Monday. Another reason seems to be the stock’s outperformance in the past three months. Its shares have risen by 25% in the past three months, much higher than the 9% rise in the CNX IT index. If Sikka manages to sustain the momentum of the past two quarters, the outperformance will undoubtedly continue.

The writer does not own shares in the above-mentioned companies.