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Infosys: Tepid third quarter - Views on News from Equitymaster

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Infosys: Tepid third quarter

Jan 13, 2011

IT services major Infosys has announced its 3QFY11 results. The company has reported a 2% QoQ growth in its sales and a growth of 3% QoQ in its net profit. Here is our analysis of the results.

Performance summary
  • Sales grow by 2.3% QoQ during 3QFY11. On a 9 month basis, sales grew by 20.6% YoY.
  • Operating margins remained flat at 30.2% during the quarter as compared to the previous quarter. On a 9 month basis, operating margins declined slightly by 0.9% YoY. This was mainly due to slightly higher cost of sales as well as higher selling & marketing expenses (both as a percentage of sales).
  • Increase in other income leads to a growth of 2.5% QoQ in net profits.
  • Due to better clarity on the growth prospects, the management has revised its FY11 earnings guidance marginally. It now expects FY11 earnings per share (EPS) to be in the range of Rs 118.7-118.9, as compared to its previous estimates of Rs 115-117. Revenue estimates have also been increased marginally. The company now expects to grow its FY11 sales by 20.5-20.8% YoY as compared to the earlier estimates of 18.5-19.4% YoY.
  • The company added 40 new clients during the quarter taking the total number of active clients to 612.

Financial performance snapshot
(Rs m) 2QFY11 3QFY11 Change 9MFY10 9MFY11 Change
Sales  69,470 71,060 2.3%     167,980    202,510 20.6%
Expenditure 48,490 49,590 2.3%     116,770     142,510 22.0%
Operating profit (EBDITA) 20,980 21,470 2.3% 51,210 60,000 17.2%
Operating profit margin (%) 30.2% 30.2%   30.5% 29.6% -0.9%
Other income 2,670 2,900 8.6% 7,380  7,960 7.9%
Profit before tax 23,650 24,370 3.0% 58,590 67,960 16.0%
Tax 6,280 6,570 4.6% 12,400 17,910 44.4%
Profit after tax/(loss)  17,370 17,800 2.5% 46,190 50,050 8.4%
Net profit margin (%) 25.0% 25.0%   27.5% 24.7%  
No. of shares 574.08 574.20   573.58 574.20  
Diluted earnings per share (Rs)*         115.0  
P/E ratio (x)*         27.9  
* On a trailing 12-months basis Note: Depreciation figures have not been disclosed
separately and hence these are included in operating expenses to calculate EBDITA margins

What has driven performance in 3QFY11?
  • The 2.3% QoQ growth in Infosys’s 3QFY11 sales was helped by all its segments. However, the company’s main business of ‘application development and maintenance’ (38% of total sales) saw a decline of 0.3% QoQ due to a 2.1% QoQ decline in application maintenance. The other key segment of ‘consulting & package implementation’ (26% of total sales), sales grew by 2.7% QoQ during the quarter. However, ‘infrastructure management’ (6% of sales) saw a decline of 1% QoQ during the quarter.

  • Based on the industries it serves, Infosys recorded the best performance from the manufacturing space which forms 20% of total sales. This segment grew by 6% QoQ during the quarter. The main ‘BFSI’ (Insurance, Banking & Financial Services) segment recorded a 5% QoQ growth in sales during the quarter. However, telecom, utilities and services saw a decline of 4% QoQ, 1% QoQ and 2% QoQ respectively. Revenues from ‘others’ also declined by 6% QoQ during the quarter.

  • As for the geographical performance, the company’s focus on other geographies led to a 12% QoQ increase in sales from these regions. Sales from Europe witnessed a 2% QoQ growth during the quarter. Sales from North America witnessed a lackluster performance with a 0.6% QoQ growth. India business grew by a robust 7% QoQ.

  • On an overall basis, the growth in sales was owing to higher volumes (man-hours billed) during the quarter. While offshore volumes grew by 4% QoQ, onsite volumes were up 2% QoQ. Utilization rates declined to 72.6% during the quarter as compared to 74.3% during the previous quarter. This was mainly on account of larger number of trainees during the quarter. The company continued its hiring spree during the current quarter as well. Infosys has hired 5,311 employees (on a net basis) during the quarter. However, the attrition rate continued to remain high. It stood at 17.5% at the end of the third quarter, as compared to 17.1% at the end of the previous quarter (ended September 2010).

    Revenue break-up
    Rs m 2QFY11 3QFY11 Change
    By service offerings      
    Application development and maintenance    27,163 27,074 -0.3%
    Application development    10,837 11,085 2.3%
    Application maintenance    16,325 15,989 -2.1%
    Business Process Management 3,890  3,979 2.3%
    Consulting Services and Package Implementation    17,923 18,405 2.7%
    Infrastructure Management 4,307  4,264 -1.0%
    Product Engineering Services 1,737  1,848 6.4%
    System Integration 3,960  3,979 0.5%
    Testing Services 5,280  5,401 2.3%
    Others 2,293  2,345 2.3%
    Total services    66,552 67,294 1.1%
    Product revenues 2,918  3,766 29.1%
    Total revenues    69,470 71,060 2.3%
    By industry vertical      
    Insurance, Banking and Financial services    24,592 25,724 4.6%
    Manufacturing    13,130 13,928 6.1%
    Retail    10,004 10,304 3.0%
    Telecom 9,240  8,883 -3.9%
    Utilities 4,377  4,335 -1.0%
    Transportation & Logistics 1,250  1,279 2.3%
    Services 3,612  3,553 -1.6%
    Others 3,265 3,056 -6.4%
    By geography       
    North America 45,711 45,976 0.6%
    Europe  15,144 15,491 2.3%
    India  1,459 1,563 7.2%
    Rest of world  7,155 8,030 12.2%

  • Infosys’s operating margins remained flat at 30.2% during the quarter. Billing rates improved slightly by 1% QoQ for onshore projects and by 3% QoQ for offshore projects. The currency movement vis-à-vis US dollar had a negative impact of 1.5% on margins. But this was mitigated by the increase in pricing. The cross currency movements also had a favourable impact on margins.

  • Other income increased by 8.6% QoQ during the quarter. However, the impact of this was offset by the increase in tax rates. As a result, net profits increased by 2.5% QoQ during the quarter. The effective tax rate stood at 27% in 3QFY11 as compared to 26.6% in 2QFY11. We see tax rates going up for the sector as a whole.

  • The company is sitting on a huge cash balance of around US$ 3.3 bn.

What to expect?
At the current price of Rs 3,208, the stock is trading at a multiple of 20.1 times our estimated FY13 earnings. Infosys’ overall 3QFY11 performance remains tepid. The management stated that the reason for this is that the clients had allocated and spent most of their IT budgets early on in 2010. As a result, the additional spending during the December quarter was negligible. This led to a lackluster performance in revenues. In terms of geographies, the management stated that they are seeing traction from both US as well as Europe. However, they expect demand recovery from Europe to lag US. The company plans to proactively continue investing in Europe to deal with the demand when the recovery takes place.

For the next year, the management expects ‘normal’ growth. This would be around mid to high teen levels. While billing rates did go up during the quarter, the management still expects them to remain flat in the coming quarters. The reason for this was that most clients were reluctant to sign on any pricing increases. The growth would be fuelled entirely by a growth in volumes. In terms of margins, the management remains optimistic that they would be able to maintain margins at current levels. In terms of wage increases, they feel that as long as growth comes in at expected levels, the company should be able to absorb any wage increases. In any case they do not expect wage hikes to be as high as those seen last year. In terms of currency, the management is optimistic that any adverse movements can be absorbed unless the movements are too sharp and drastic.

At the current levels, we feel that most of the growth for the company has already been priced in. We maintain our 'Sell' view on the stock. (Research Pro subscribers please click here)

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