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  • Infosys Q2 results: Strong overall performance despite margins glitch

    Publish Date: October 17, 2018

    Recommendation: Add


    Target price: Rs 780

    Let’s start with the good news first: Infosys surpassed market expectations to clock higher revenue growth in the second quarter ended September 30.

    The country’s second-largest IT services provider also enthused market-watchers by announcing it has bagged fresh mega deals worth $2 billion, which is an all-time high for the company.

    The bad news? The IT firm saw its operating profit margin shrink despite rupee depreciating 9.5% against the US dollar in the last three months. A weaker rupee usually lifts Indian IT companies’ balance sheet because they are dominantly export-oriented businesses.

    It must be noted though that the company has benefited from currency depreciation. But they have used that money to provide higher-than-expected promotions and wage revisions to rein in industry-high employee turnover. They are also planning to use the money to reinvest in their business (details are provided later in the piece).

    Here’s a detailed analysis of the company second quarter results:

    Better-than-expected revenue growth

    Market-watchers had expected Infosys to report revenue growth of 2.4% (in constant currency terms) from the preceding quarter.

    Instead, the company announced strong revenue growth of 4.2% (quarter-over-quarter) — highest in eight quarters — and 8.1% from last year’s corresponding period.

    The revenue growth results are in constant currency (c/c) terms. Most export-heavy IT firms report their revenues in constant currency terms because this system eliminates exchange rate fluctuations.

    Going back to the pleasantly surprising revenue growth, most verticals delivered for the company this time. Its financial services and retail wing were the frontrunners — both of them clocked 5.8% and 5.9% revenue growth, respectively, this quarter.

    Mega deals

    The company signed 12 large deals exceeding $2 billion, nearly two times the amount announced in the preceding three months.

    It is particularly impressive because they have been stricken by instability at the top: the company saw its chief financial officer and executive vice president exit in quick succession in the last few months.

    In light of this, the reasons for winning large deals can be attributed to a better demand environment — US businesses have more money in hand following US government’s decision to slash corporate taxes — and installation of a new CEO, Salil Parekh.

    Decline in margin

    The company’s operating profit margin is at 23.7% — a 20-quarter low — despite currency depreciation and higher productivity adding 80 basis points and 70 basis points, respectively, to the overall numbers. Operating profit margin indicates a company’s profitability and operational efficiency.

    Reasons for margin decline: High attrition and reinvestment plans

    The gains made from rupee depreciation and higher productivity were wiped out because the company was compelled to give better pay packages and promotions to select staffers in order to contain the number of employee exits.

    The company also had to pay a substantial amount to its sub-contractors as its become more stringent to get US visas now and because there’s a high demand for digital skills. In percentage of revenue terms, sub-contracting costs increased to 7.4% from 6.8% in the preceding three months.

    Although attrition rates have subsided a little — from industry-high 23% last quarter to 22.2% now — it still remains a cause for concern. High employee churn often lowers productivity and company’s earnings in the long run.

    Meanwhile, Infosys also wants to invest in its sales force and enhance its digital services, which will expectedly put pressure on its margins.

    The company will have to be careful though. We feel that they may become vulnerable if the gains made from currency depreciation recede in the next few months.

    ‘Hire American’ policy

    After US President Donald Trump thrust — “Buy American. Hire American” — as a rallying cry for stricter entry of skilled workers in his country, Infosys made a public pledge to recruit 10,000 American workers by 2019.

    The company has made good progress on that — hiring 5,800 American citizens so far. They also trained 1,400 fresh graduates for three months before recruiting them for on-site projects.

    The IT giant has also launched tech centers in Indianapolis, Rhode Island, North Carolina and Connecticut. Last month, Mint reported that the company was planning to open its next centre in Arizona.

    Dividend payout

    The management has declared an interim dividend payout of Rs 7 per share this quarter.


    Disclaimer:

    REDUCE rating suggests we expect the stock to deliver -5 to +5% returns over the next 12 months.

    BUY rating suggests we expect the stock to grow around 15% in the next 12 months.

    ADD rating suggests we expect the stock to deliver more than 5% returns in the next 12 months.

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