Infosys Ltd (Q1 FY13)

CMP Rs2,265, Target Rs2,400, Upside 5.9%

• Material pricing correction leads to below estimate dollar revenues
• Highly restricted growth across verticals/service lines; Europe down on project cancellation
• OPM corrects 200bps despite rupee weakness and absence of wage hikes
• FY13 guidance materially below expectation; Wage hikes deferred further    
• Reduce FY13E/FY14E EPS by 5/4%; Stock expected to remain range bound; Maintain MP

Material pricing correction leads to below estimate dollar revenues

Q1 FY13 dollar revenues of US%1.752bn came in 1.1% lower than bottom end of its guidance and 1.6% lower than our expectation. While the volumes were higher than expected at 2.7% qoq, the realisation decline of 3.2% (in constant currency), adverse cross currencies and one-time reversal of accrued revenues led to the below estimate dollar revenues. On the pricing front, lower contribution of higher priced consulting services and sporadic pricing negotiation (esp. by FSI clients) led to the correction. Company maintained pricing environment to be stable going forward. Rupee revenues were up 8.6% qoq on the back of material rupee weakening. Company has registered eight deals wins, four each on Consulting/SI And Business IT segments. Management commentary on key developed markets continued to be cautious with clients decision making delays worsening in the current volatile macro economic environment. 

Highly restricted growth across verticals/service lines; Europe down on project cancellation

Growth across various verticals and services remained weak with only a few posting decent revenue growth during the quarter. Amongst the large verticals, Retail and Manufacturing led the growth with 5.8% and 2.2% qoq dollar revenue growth. The strong de-growth (25% qoq) in utilities vertical was on the back of the project cancellation by an European client. Insurance too declined strongly at 5.4% qoq.  Within services, consulting/system integration de-grew the most at 4.9% due to its discretionary nature. Testing services grew the fastest at 5.3% qoq in dollar terms. Within geographies, Americas stabilized posting 1.6% qoq growth (versus 4% de-growth in Q4 FY12). On the other hand, due to reasons discussed above, Europe declined 8.4% qoq in dollar terms. Top 5/top10 clients grew appreciably 4.1%/2.6% qoq in dollar terms. Also, Top 2-5 clients grew faster at 5.9% qoq and non Top10 clients de-grew 2.3% qoq.

OPM corrects 200bps despite rupee weakness and absence of wage hikes

Disappointment with the results continued with a surprising correction of 200bps of the OPM. This unanticipated fall came in despite the material rupee depreciation (8% sequentially), absence of wage hikes and sizeable utilization headroom. The pricing correction of 3.2% in constant currency terms, higher visa cost, increased local hiring and flat utilization (despite low employee addition and decent volumes) all contributed to the fall in the operating margin. Other income of Rs4.76bn came in lower than expected due to lower interest income. Gross employee additions were 9200+ but net employee addition was largely flat (0.8% of Q4 FY12 base). The quarterly annualized attrition jumped to 21.5% due to higher employee exits for further studies and possibly on the back of no wage hike expectation. Company continued to guide for 35000 employee additions on gross basis in FY13.

FY13 guidance much below expectation; Wage hikes deferred further 

The FY13 dollar revenue growth guidance was brought down materially to at least 5%, coming in below our estimates of 6-8% growth. Also, on the back increased client decision making delays, the company has temporarily suspended quarterly revenue guidance. Company indicated that currency impact (150bps), Pricing impact (300-400bps) and general weakness in business to have led to the massive reduction in the guidance. On the OPM front, company expects to maintain margin in the range of 50-100bps yoy (ex-wage hike impact) for FY13. The company, nonetheless, has maintained its full year volume growth guidance at 9-10%. The full year guidance implies a Q2-Q4 CQGR of 3.1% in US dollar terms. The rupee EPS guidance of atleast Rs166.43 too was materially below our expectation of Rs176-178 largely due to the lower than expected revenue guidance. While the company promoted 20000 of Infosys employees, the wage hike decision has been further postponed to the Q3 FY13.

Reduce FY13E/FY14E EPS by 5/4%; Stock expected to remain range bound; Maintain MP

Infosys missed its quarterly dollar revenue guidance for the second time in a row. While the revenue miss would not be so material, the instances of sporadic pricing cuts and project delays are notably concerning. Continued paring of guidance seemingly indicates heightened volatility in two large chunks of business – consulting/SI and Financial services (forming 58%+ of the total revenues). This too seems to be Infy’s specific issue as growth for the same pieces was significantly better for peer TCS during Q1 FY13. An implied 3% CQGR for Q2-Q4 FY13 also remains bit difficult to achieve, in our view. We tweak our rupee EPS estimates for FY13E/FY14E by 5%/4% respectively to factor in the same. Though valuations suggest limited downside, an upside too should be capped. We anticipate the stock to remain range bound for near term till sustained performance is evident for Infosys. Maintain MP with reduced 9-month TP of Rs2400.