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Year-on-year growth in organic revenue dropped to 8% in the March quarter, down from 8.5% in the December quarter and the high of 11.1% in the September quarter. Photo: Bloomberg
Year-on-year growth in organic revenue dropped to 8% in the March quarter, down from 8.5% in the December quarter and the high of 11.1% in the September quarter. Photo: Bloomberg

Infosys’s results bring little comfort to investors

Neither the company's March quarter results, nor its guidance give signs that the company is out of the woods

Early on Tuesday, investors seemed relieved that Infosys Ltd had guided for 7-9% revenue growth in dollar terms in fiscal year 2014-15, higher than the Street’s expectation of 6-8% growth guidance. The Infosys stock rose by 3.6% initially. But later in the day, investors came around to the view that neither Infosys’s March quarter results nor its guidance give signs that the company is out of the woods; the Infosys stock ended the day just 0.76% higher. Interestingly, shares of rival Tata Consultancy Services Ltd (TCS) rose by 4.2%, and those of Wipro Ltd rose 3.9%; signalling a shift in investors’ positions. This is despite the fact that Infosys had already underperformed TCS shares by about 11% in the past month.

Expectations were running low since the company issued an effective ‘profit warning’ on 12 March and the slightly better-than-expected guidance should have cheered investors. But there are a number of worrying factors in the company’s results.

Year-on-year growth in organic revenue dropped to 8% in the March quarter, down from 8.5% in the December quarter and the high of 11.1% in the September quarter. Organic growth calculations assume a quarterly revenue run rate of $70 million for Lodestone Holding AG, which was acquired in late 2012. Many investors had come to the conclusion that the worst is over for the company when it reported double-digit growth in Q2 last year. But things have gone downhill since then. The company has blamed this on some company-specific issues such as a decline in revenue from some clients who are facing a slowdown and the fact that it gets a higher proportion of revenue from discretionary IT spending, such as consulting and systems integration. According to Infosys, demand for these services is still sluggish. Besides, companies in some sectors such as retail and hi-tech have cut spending and are likely to remain weak in the near term. For the rest of the business, the company expects a normal seasonal trend in revenues, where growth picks up in the first two quarters and then tapers in the second half. Given the continued sluggishness in some sectors, it might turn out that the company may struggle to meet the higher end of its guidance, since that will require average quarterly growth of 2.9% or incremental revenues of around $63 million each quarter. In the past eight quarters, quarterly incremental revenue has averaged $35 million and have exceeded $60 million only twice. Also, note that Street estimates of revenue growth were around 10% just ahead of the results announcement and may have to be toned down.

Another major worrying sign is the high attrition at the company. Quarterly annualized attrition has been over 20% for a long time now, and last quarter it stood at 22.7%. Analysts at JPMorgan Chase and Co. said in a note, “More than senior management attrition, what’s a bit more worrying for us is attrition at the mid-management level—account managers at the client end and project/programme managers at the delivery end. Senior management helps open doors, but it is mid-management that is the key to mining and deepening accounts." They added that a net employee addition of 4,000 should be taken as a positive, but the company reported a net addition of 2,001 employees.

For the whole year, the company added to its employee base by an anaemic 2.37%, which could reflect an expectation that revenue may not bounce back quickly. The company’s response to this is that it still has some leeway since employee utilization averaged 76% last year excluding trainees, and that this yardstick can go up to 82% comfortably.

One silver lining is that the company has done well on growing margins in the past few quarters—margins grew by 48 basis points sequentially last quarter, on the back of a nearly 200 basis points jump in margins in the December quarter.

One basis point is one-hundredth of a percentage point.

But margins can drive earnings only to some extent and it’s imperative that revenue growth picks up soon. Similarly, while the increase in dividend payout is welcome, it won’t drive a re-rating of the stock.

Finally, the company perhaps hasn’t seen the last of the internal leadership-related challenges. Infosys has already seen a flux in senior management in the recent past. If the company now decides to bring in an outsider as its new chief executive officer, it might result in another period of instability and transition issues. Some of the challenges may be fewer if the company’s board decides to choose an insider instead. But until the decision is known, the uncertainty can act as another overhang over the stock.

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