Infosys investors blow hot and cold on Q3 revenue beat, guidance revision

Infosys stock tanked around 6% on Friday on the NSE. Its ADR listed on New York Stock Exchange plunged 5.7% on Thursday, (File Photo: Reuters)
Infosys stock tanked around 6% on Friday on the NSE. Its ADR listed on New York Stock Exchange plunged 5.7% on Thursday, (File Photo: Reuters)

Summary

  • While Infosys reported a revenue growth in a weak quarter, concerns linger over increasing pass-through revenues as it may pose headwinds to growth in FY26

Infosys Ltd investors are edgy and hardly impressed by the positives of its December quarter (Q3FY25) results. Sequential constant currency (CC) revenue grew by 1.7% in a seasonally weak quarter, beating consensus estimate of 0.8%.

This prompted Infosys to raise its FY25 year-on-year constant currency (CC) revenue growth guidance 4.5-5% from 3.75-4.5% earlier. With that, the mid-range of the guidance increased by around 60 basis points (bps). But the devil is in the details.

The beat in Q3FY25 revenue growth was largely driven by higher revenues from sale of third-party items bought for service delivery to clients, also known as pass-through revenue. In fact, the cost of software packages for service delivery to clients as a percentage of Infosys’s revenue increased by 150 bps to 9.6% in Q3FY25, the highest ever, highlighted Kotak Institutional Equities.

Gradual increase in such revenue has weakened the quality of revenue mix, said the Kotak report, adding that third-party software sales have a significantly lower Ebit margin and distort the cost structure.

In simple terms, this kind of bump-up in revenue raises concerns over the sustainability of earnings growth. “The revised guidance implies a sequential decline of 2.5% to 0.6% in Q4, this because of absence of pass-through income and the continued impact of partial furloughs," said Emkay Global Financial Services.

Small wonder then that Infosys stock tanked around 6% on Friday on the NSE. Infosys American Depositary Receipt (ADR) listed on New York Stock Exchange plunged 5.7% on Thursday.

Infosys is seen as a key beneficiary of improvement in discretionary spending by IT clients. With that, lesser reliance on bundled deals for growth can help reduce Infosys’s dependence on third party software sales. But this problem is not unique to Infosys.

“Pass-through revenues have inched up over the past couple of years across the industry, especially for large caps (Infosys and Tata Consultancy Services Ltd). While we concede that these revenues are unavoidable in the context of mega deals, we expect them to pose headwinds to growth in FY26 for large caps," said Motilal Oswal Financial Services report on 17 January.

Also Read: Infosys counters that Ravi Kumar delayed software before joining as Cognizant CEO

Further, the total contract value (TCV) of large deal wins rose sequentially to $2.5 billion from $2.4 billion in Q2, but has declined year-on-year. TCV included around 63% from new deals. During the quarter, Infosys won 17 large deals across verticals. Geographically, it bagged 11 deals spread in North America and Europe. “Contrary to comments from its peers, Infosys saw its large deal pipeline grow, while short-cycle deals remained flat sequentially," added the Motilal Oswal report.

Earnings before interest and tax (Ebit) margin improved by 20 basis points sequentially to 21.3% despite headwinds from furloughs and higher third-party expenses. Tailwinds from currency benefits, Project Maximus, and lower provisions for post-sales support were partially offset by headwinds due to furloughs and fewer working days. The operating margin guidance for FY25 was unchanged at 20% to 22%. Wage hikes, phased over Q4 and Q1FY26, could be potential speed bumps, while cost optimization measures may help mitigate the adverse impact to some extent.

Meanwhile, in FY25 so far, Infosys Ltd stock has gained 21%, marginally ahead of the Nifty IT index. It trades at FY26 price-to-earnings multiple of 26.5 times, at par with peer TCS, showed Bloomberg data. Likely weakness in Q4FY25 may well mean Infosys's valuation is at a risk of moderation.

Also Read: Infosys’ mixed signals give cold vibes to investors

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