17 Sep 2012

Update |Sector: Technology

Infosys

BUY

CMP: INR2631

TP: INR 2815

No comeback in discretionary and BFSI spends; Pricing pressure

in pockets of BFSI continues; Confident of meeting FY13

guidance

We interacted with the management at Infosys (INFO IN, CMP INR2631, MCAP USD

28b, Buy) to get an insight on 2QFY13 and the overall demand environment. Key

takeaways:

- There has been no change in the environment in the last couple of months; the

company is not seeing any turnaround in troubled areas, especially discretionary

spends and BFSI. The component of budget under-spends thus far in the

calendar year is high.

- It is not expecting budget flush towards the end of the CY12, so growth may be

evenly spread across quarters. With wage hikes absent, and utilization moving

within a tight band across quarters, margins are expected to be stable, rather

than witness quarterly seasonality. Expect pricing decline on the back of some

more price cuts in troubled pockets in BFSI and residual impact of cuts in

1QFY13. But reported realization may not see a significant change as base of

USD15m revenue reversal in 1Q will push the realization metric up.

- The company continues to actively scout for acquisitions in the Products,

Platforms and Services segment (PPS). After Lodestone, Consulting may not see

an acquisition any time soon. The Board believes 30% payout ratio is optimal

given inorganic growth plans.

- Infosys reiterated its focus on Business Operations segment, stating that if it

qualified a deal as important, it will be flexible and aggressive on pricing in

chasing the same. However, peer-matching / leading growth rates remain a

function of resurgence in discretionary spends.

Valuation and View: Near-term triggers missing, but reassurance in meeting the

guidance limits downside

- Given continued cautiousness in its outlook, upside in the stock could be

restricted in the near term, despite increasing confidence and visibility in

meeting 5% FY13 USD revenue growth guidance. We expect pricing concerns to

be behind the company post 2QFY13, and greater aggression should help deliver

on a non-worrying volume growth guidance.

- We expect Infosys’ USD revenues CAGR of 10% over FY12-14 and EPS CAGR of

12%. The stock trades at 15.6x FY13E and 14.5x FY14E. Maintain

Buy,

with a

target price of INR2,815.

1

Infosys

Environment: Remains challenging without any noticeable change; budget under-

spends high; but recent deal wins increase the confidence in meeting 5% growth

guidance

- Infosys has not seen any change in the demand environment in the past couple

of months, challenges continue to mar decision making. There is no semblance

of resurgence either in discretionary spending or in BFSI. While transformational

work is not absent, it has been broken up and is being dished out in multiple

phases. Thus far in the calendar year, the component of budget under-spends

remain high.

However, recent deal wins like Harley Davidson have increased the company’s

visibility on 5% USD revenue growth in FY13. Ramp-up in deals varies from contract

to contract. Larger sized deals are still gradual in offtake of work, whereas shorter

duration, quick ROI projects are seeing execution as planned.

BFSI revenues have declined for the past 2 quarters; headwinds

persist but expect stable volumes and pricing going forward

QoQ pricing decline in 2QFY13 may not show in realization metric

2QFY13: Sequential pricing decline may not be visible in realization rates; revenue

growth may be evenly spread; margins unlikely to follow seasonal changes

- Despite under-spent budgets thus far in the calendar year, Infosys does see

much reason to believe in a budget flush towards the end of the year. Also,

some recent positive news from Europe and US came too late for such a flush to

materialize. As a result, 2QFY13 may see ~3% QoQ USD revenue growth, in line

with the required CQGR over 2Q-4Q to meet 5% full year guidance.

- Pricing pressure in pockets of BFSI continued during the quarter, in addition to

which, there will be some residual impact from discounts offered in the last

quarter, that will affect 2QFY13. However, the realization rate may not change,

as the offset could come from USD15m revenue reversal base of 1QFY13, which

contributed ~80bp to pricing decline.

- The company does not expect the normal seasonality pattern seen in operating

margins. Given no wage hike and low utilization, margins in constant currency

may be within a range. For 2QFY13, there will be ~USD15m impact from

promotions, headwind of ~85bp to EBITDA margins.

17 Sep 2012

2

Infosys

Not much has changed on the expectations of evenly spread QoQ

revenue growth and stable margins in the guided band

Acquisitions and Cash plans: ‘10% of revenues’ is acquisition cap on a single

transaction; Buys now likely only in PPS; 30% payout ratio seen as optimal

- After the acquisition of Lodestone for a total consideration of USD345m, it is

unlikely that Infosys would foray into another acquisition in the Consulting

space. While there are still pockets like BFSI and Healthcare where gaps in

Consulting need to be plugged, that is unlikely to be top priority from

acquisitions perspective. The company continues to very actively scout for

targets in the Products, Platforms and Solutions (PPS) segment. The cap of 10%

of revenues applies per transaction and is not the ceiling for cumulative

acquisition spend.

- The Board has thus far deemed 30% payout ratio to be optimal, despite the

huge cash pile, considering acquisitions being imperative to Infosys 3.0 strategy.

This may not change anytime in the near future.

Growth strategy: Aggression not lacking in Business IT operations; but peer-

matching / leading growth rates contingent on resurgence in discretionary spends

- Infosys reiterated its focus on Business Operations segment, and cited deals like

Harley Davidson as an example of its openness to different kinds of

engagements like employee takeover. The focus is on increasing differentiation

through automation so as to maintain productivity despite pressures from

commoditization.

- However, given higher proportion of discretionary revenues in its portfolio,

matching growth rates of peers is contingent on resurgence in discretionary

spending. Signs of that happening in the near future are few, even though

clients acknowledge that the transformation work has been kept on the back-

burner for more than its fair share.

17 Sep 2012

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Infosys

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17 Sep 2012

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