Infosys’s growth on a sequential basis was double than that of Tata Consultancy Services (TCS)
But the firm’s profit margins were hit due to sub-contracting costs as well as wage inflation
IT services firm Infosys Ltd reported stellar revenue growth in the June quarter. Its constant currency revenue growth of 4.8% sequentially easily beat the consensus estimate of 3.6% growth. Infosys’s growth also happened to be double of what was reported by industry leader Tata Consultancy Services (TCS), which had missed estimates to report only 2.4% growth last week.
What’s more, Infosys raised its FY22 revenue growth guidance to 14-16% from 12-14%. Most analysts had expected the company to raise the target to a 13-15% range.
Infosys’s American Depository Receipts (ADRs), which are listed on the New York Stock Exchange, were up only about 2% at press time.
While the strong revenue growth and deal wins were big positives, profit margins took a beating, and poured cold water on investors’ hopes of an earnings upgrade. “Earnings revisions are expected to be marginal, as revenue upgrades will get negated by downward revisions on the margin front," said an analyst at a domestic institutional brokerage, seeking anonymity.
Infosys’s operating margin fell 80 basis points sequentially, even though its salary hikes were due only in Q2. Wage inflation, reflected in higher employee and sub-contracting costs, was still the culprit. Given the strong demand, there is a war for good talent in some segments, leading to higher attrition and higher employee costs.
Infosys saw its voluntary attrition rise from 10.9% in Q4FY21 to 13.9% in Q1FY22. “A 300 basis points rise in attrition and the related monetary measures to contain it will pose a threat to the company’s margins in the coming quarters as well," said another analyst, also seeking anonymity. Some analysts said that since wage inflation is visibly hurting margins, IT services firms will have a case for negotiating price hikes with some customers. “We see a case for higher offshore pricing (for the niche and the right digital skills to start with), aided by strong growth/demand, offshore shift (reflected in higher offshore delivery and strong pick-up in hiring), which could negate some of the margin/cost related concerns for the Street (including us)," analysts at JM Financial Institutional Securities Ltd said in a note, adding that in earlier periods, such as between FY05 and FY08, offshore pricing had increased on the back of strong demand.
The management said that it has a few margin levers, which include automation and pyramid management, and pricing on digital could be raised. But there are no clear signs of this happening yet, which explains the muted reaction of the Infosys stock, despite the strong outlook on revenue growth and deal wins. In a post-earnings conference call, the management said: “We have seen strong growth in Q1, the deal pipeline is good, we are seeing good traction in digital transformation among large deals; putting all these together gives us the confidence to increase our revenue growth guidance to 14-16%. We expect pricing to remain stable."
Analysts at Jefferies India Pvt. Ltd said the revised revenue guidance reflects its strong growth visibility. Another highlight was Infosys’s robust deal wins. Its large deal bookings rose 22% sequentially to $2.6 billion in Q1. As pointed out earlier, Infosys is clearly leading on revenue growth, and the trend has accelerated post-covid. Infosys’s quarterly dollar revenues are 16.6% ahead of pre-covid levels (Q3FY20), while in the case of TCS, they are up 10.2%. In the past one year, the Infosys stock has rallied by 101%, massively beating TCS, which rose 48%. The valuation gap between the two stocks has also narrowed considerably.