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Infosys: Getting back on track - Views on News from Equitymaster

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Infosys: Getting back on track

Jan 10, 2014

IT services major Infosys Ltd has announced its third quarter results for the financial year 2013-2014 (3QFY14). The company has reported a 0.5% quarter-on-quarter (QoQ) growth in its sales and a 19.4% QoQ growth in its net profits. Here is our analysis of the results.

Performance summary
  • Consolidated sales increased by 0.5% QoQ during 3QFY14. In US dollar terms the growth was 1.7% QoQ.
  • However, operating profits were up by 14.9% QoQ. This was due to good control over employee costs and selling, general and administrative (SG&A) costs on an absolute basis. The operating
  • margin, which came in at 25%, was up from 21.9% seen in 2QFY14.
  • This good growth in operating profit combined with a big jump of 43.3% QoQ in other income, resulted in the profit before tax (PBT) growing by 19.2% QoQ.
  • The tax rate for the quarter fell marginally to 27.9%. The net profit for the company increased by 19.4% QoQ.
  • The company added 54 new clients during the quarter.

Consolidated Financial Snapshot (IFRS)
(Rsm) 2QFY14 3QFY14 Change 9MFY13 9MFY14 Change
Sales 129,650 130,260 0.5% 298,980 372,580 24.6%
Expenditure 101,280 97,670 -3.6% 219,310 284,980 29.9%
Operating profit (EBIT) 28,370 32,590 14.9% 79,670 87,600 10.0%
Operating profit margin(%) 21.9% 25.0%   26.6% 23.5%  
Other income 5,100 7,310 43.3% 16,850 18,180 7.9%
Profit before tax 33,470 39,900 19.2% 96,520 105,780 9.6%
Tax 9,400 11,150 18.6% 26,250 29,220 11.3%
Profit after tax/(loss) 24,070 28,750 19.4% 70,270 76,560 9.0%
Net profit margin (%) 18.6% 22.1%   23.5% 20.5%  
No. of shares         574.2  
Diluted earnings per share (Rs)*         175.0  
P/E ratio (x)*         20.3  

What has driven performance in 3QFY14?
  • In terms of service offerings, the Business IT services division witnessed a growth of 0.3%QoQ. The performances of the individual verticals in this division were as follows. Application development witnessed a fall in revenues by 0.2% QoQ, application maintenance witnessed growth of 1% QoQ, Infrastructure Management Services (IMS) witnessed a fall in revenues by 3.7% QoQ, Business Process Management (BPM) witnessed growth of 4.4% QoQ, Product Engineering Services (PES) witnessed fall in revenues by 2.6% QoQ, testing services witnessed growth of 4.1% QoQ, and others witnessed a fall in revenues by 8.3% QoQ. The Consulting and Package Implementation division witnessed a growth of 0.8% QoQ. Finally, the Products Platforms and Solutions division witnessed a growth of 0.5% QoQ.

  • Based on the industry verticals, Banking, Financial Services and Insurance (BFSI) grew by 0.8% QoQ, Manufacturing fell by 1.3% QoQ, Energy and Utilities grew by 2.4% QoQ, Retail grew by 2.4% QoQ, Transportation and Logistics fell by 10.7% QoQ, Life Sciences and Healthcare grew by 5% QoQ, Telecom fell by 4.4% QoQ and others grew by 3.9% QoQ.

  • In terms of geographies, North America saw a fall in revenues of 2% QoQ, Europe saw a growth of 4.2% QoQ, India saw a growth of 8.8% QoQ and the rest of the world saw a growth of 3.8% QoQ.

    Revenue break-up
    Rs m 2QFY14 3QFY14 Change
    By service offerings
    Application development and maintenance 45,507 45,721 0.5%
    Application development 20,744 20,711 -0.2%
    Application maintenance 24,763 25,010 1.0%
    Business Process Management 6,612 6,904 4.4%
    Infrastructure Management 9,335 8,988 -3.7%
    Product Engineering Services 4,278 4,168 -2.6%
    Testing Services 10,891 11,333 4.1%
    Others 2,982 2,735 -8.3%
    Total IT services 79,605 79,849 0.3%
    Consulting, Package Implementation & Others 43,173 43,507 0.8%
    Products, Platforms and Solutions 6,871 6,904 0.5%
    Total revenues 129,650 130,260 0.5%
    By industry vertical
    Insurance, Banking and Financial services 43,303 43,637 0.8%
    Manufacturing 30,079 29,699 -1.3%
    Retail 20,355 20,842 2.4%
    Communication (Telecom) 10,761 10,291 -4.4%
    Energy (Utilities ) 6,612 6,774 2.4%
    Transportation & Logistics 2,334 2,084 -10.7%
    Lifesciences & Healthcare 8,687 9,118 5.0%
    Others 7,520 7,816 3.9%
    By geography 
    North America 79,735 78,156 -2.0%
    Europe  31,116 32,435 4.2%
    India 3,112 3,387 8.8%
    Rest of world 15,688 16,283 3.8%

  • On the operating front, Infosys continued its drive to keep costs in check. Direct expenses which include software development costs and employee expenses did not increase significantly on an absolute basis this quarter. Also, selling and administrative costs fell on an absolute basis by 14.9% QoQ and 18.7 QoQ respectively. This was the reason for the big expansion in the operating margin from 21.9% in 2QFY14 to 25% in this quarter despite a muted performance on the topline.

  • At the net level, the bottomline was driven largely by the good operating performance, a jump of 43.3% in other income and a marginal drop in the tax rate. The company's net profit margin expanded to 22.1% in the quarter from 18.6% in 2QFY14.
What to expect?
At the current price of Rs 3,548, the stock of Infosys is trading at 20.3 times our estimated FY16 earnings per share.

The December quarter is a seasonally weak quarter for Indian IT firms and this was clearly evident in the company's results. US dollar revenues were up only 1.7% QoQ while in rupee terms, it was up just 0.5% QoQ. The appreciation of the rupee in the last three months of 2013 has also been a factor in the topline performance.

The cost optimization measures announced by the company over the last six months are now visible in the results. The management maintained that rationalisation of onsite costs would continue as more work was being moved offshore. This would be the main driver for the company's margins in the next one or two quarters. Onsite volumes fell 3.4% QoQ in this quarter.

The management sounded confident that sales growth would return to industry leading standards within six to twelve months. To this end they have invested heavily in sales and marketing teams and have completed an overhaul of the existing sales process. The company is now focused on winning large software contracts. The company won three deals of a size greater that US$ 100 m in the quarter.

The company's employee utillisation rate continued to improve. In the quarter gone by, it stood at 78% (excluding trainees) compared to 77.8% in 2QFY14. The management said that they want to take the utillisation rate above 80% in the coming quarters. The employee count stood at 158,404 at the end of 3QFY14 compared to 160,227 at the end of 2QFY14.

The management went to great lengths of point out that the recent spate of high profile exits from the top management would not affect the business negatively. They clarified that the recent appointment of two presidents and the winding up of the executive council was in line with their strategy to develop a strong second-tier leadership structure. However they also pointed out that no decision had been taken yet about the appointment of a new CEO when S.D Shibulal retires in March 2015.

Considering the future prospects of the company as well as the valuations, we maintain our ‘hold' view on the stock from a FY16 perspective.

We would like to gently remind you that your allocation to equities should be decided upon after keeping aside some safe cash. Also within your overall exposure to equities please ensure that you broadly follow our suggested asset allocation and that no single stock comprises more than 5% of your portfolio.

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