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Infosys: The recovery continues - Views on News from Equitymaster

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Infosys: The recovery continues
Apr 15, 2014

India's second largest software firm Infosys has announced its fourth quarter results for the financial year 2013-2014 (4QFY14). The company has reported a 1.2% quarter-on-quarter (QoQ) decline in its sales and a 4.1% QoQ growth in its net profits. Here is our analysis of the results

Performance summary
  • In rupee terms the consolidated sales decreased by 1.2% QoQ during 4QFY14. In US dollar terms the decline in revenues was 0.4% QoQ.
  • However, operating profits were up by 0.7% QoQ. This was due to good control over employee costs and sales and marketing expenses on an absolute basis.
  • The operating margin, which came in at 25.5%, was up from 25% seen in 3QFY14.
  • The other income also jumped by 16.4% QoQ. This helped the profit before tax rise by 3.6% QoQ
  • The tax rate for the quarter was marginally lower on a sequential basis at 27.6% compared to 27.9% in 3QFY14.
  • The net profit for the company came in at Rs 29.92 bn an increase of 4.1% QoQ.
  • The company has declared a final dividend of Rs 43 per share.

Consolidated financial summary
(Rs m) 3QFY14 4QFY14 Change FY13 FY14 Change
Sales 130,260 128,750 -1.2% 403,520 501,330 24.2%
Expenditure 97,670 95,940 -1.8% 299,230 380,920 27.3%
Operating profit (EBIT) 32,590 32,810 0.7% 104,290 120,410 15.5%
Operating profit margin (%) 25.0% 25.5%   25.8% 24.0%  
Other income 7,310 8,510 16.4% 23,590 26,690 13.1%
Profit before tax 39,900 41,320 3.6% 127,880 147,100 15.0%
Tax 11,150 11,400 2.2% 33,670 40,620 20.6%
Profit after tax/(loss) 28,750 29,920 4.1% 94,210 106,480 13.0%
Net profit margin (%) 22.1% 23.2%   23.3% 21.2%  
No. of shares         574.2  
Diluted earnings per share (Rs)*         185.4  
P/E ratio (x)*         17.6  
*On a trailing 12 months basis

What has driven performance in 4QFY14?
  • In terms of service offerings, IT services grew by 0.6% QoQ. The consulting and the products and platforms business witnessed a contraction in revenues by 3.8% QoQ and 4.9% QoQ respectively. Within IT services, Product Engineering Services (PES) grew the fastest by 5% QoQ. This was followed by Testing and Infrastructure Management Services (IMS) which grew by 4.5% QoQ and 3.1% QoQ respectively. The laggard in this quarter was Application Development and Maintenance (ADM) which saw a fall in revenues by 1.7% QoQ.

  • Based on the industry verticals, the fastest growth was seen in the telecom and transportation verticals which grew by 7.6% QoQ and 5% QoQ respectively. The healthcare and retail verticals were a drag on this quarter's top line performance as the revenues from these verticals were down 6.8% QoQ and 4.2% QoQ respectively.

  • In terms of geographies, revenues from North America contracted by 1.5% QoQ while revenues from Europe were flat on a sequential basis.

    Revenue break-up
    Rs m 3QFY14 4QFY14 Change
    By service offerings
    Application development and maintenance 45,721 44,934 -1.7%
    Application development 20,711 19,956 -3.6%
    Application maintenance 25,010 24,978 -0.1%
    Business Process Management 6,904 7,081 2.6%
    Infrastructure Management 8,988 9,270 3.1%
    Product Engineering Services 4,168 4,378 5.0%
    Testing Services 11,333 11,845 4.5%
    Others 2,735 2,833 3.5%
    Total IT services 79,849 80,340 0.6%
    Consulting, Package Implementation & Others 43,507 41,844 -3.8%
    Products, Platforms and Solutions 6,904 6,566 -4.9%
    Total revenues 130,260 128,750 -1.2%
    By industry vertical
    Insurance, Banking and Financial services 43,637 43,131 -1.2%
    Manufacturing 29,699 29,613 -0.3%
    Retail & CPG 20,842 19,956 -4.2%
    Telecom 10,291 11,073 7.6%
    Energy & Utilities 6,774 6,824 0.7%
    Transportation & Logistics 2,084 2,189 5.0%
    Lifesciences & Healthcare 9,118 8,498 -6.8%
    Others 7,816 7,468 -4.5%
    By geography
    North America 78,156  76,993 -1.5%
    Europe 32,435 32,445 0.0%
    India 3,387 3,348 -1.2%
    Rest of world 16,283  15,965 -1.9%

  • On the operating front, the company's cost containment efforts are certainly paying off. The company's total cost of sales decreased by 2.5% on a QoQ basis. This was due to a 0.7% decline in sequential onsite volumes in terms on man-hours. This is in line with the company's efforts to reduce onsite personnel. This was the main reason for the sequential fall in operating expenditure by 1.8%. Thus despite a fall in the topline of 1.2% on a sequential basis, the operating margin improved by 0.5% QoQ.

  • At the net level, the net margin also improved to 23.2% from the level of 22.1% seen in 3QFY14. Infosys has reported a growth in the bottom line of 4.1% QoQ driven largely by the cost reduction exercise currently underway within the company.
What to expect?
At the current price of Rs 3,260, the stock of Infosys is trading at 17.6 times its trailing twelve months earnings per share.

In the last quarter of the financial year, Infosys had to face client specific issues with regards to the retail vertical. The harsh weather conditions in the US had led to several clients ramping down projects temporarily. This was the main reason for the poor topline performance. However this is expected to be a one quarter phenomenon. Growth will pick up slowly going forward.

The company added 50 new clients in the quarter. Four large deals were also signed, one of which was a landmark multi-million dollar deal with Volvo Corporation. The sales and marketing efforts of the last six months have begun to pay off. The company has managed to hold pricing power stable in the financial year despite attempts to get growth back on track. Infosys has lost pricing power to a large extent in commoditised services like application development and infrastructure management but the company has compensated for this by mining their largest clients better. This strategy of focusing on key clients for large deals which have pricing power and at the same time, going after sales aggressively, will pay off in the long run.

The company's onsite cost reduction exercise continues relentlessly. Every quarter Infosys has been shifting more employees back to its Indian centers. This has clearly had a positive impact on the operating margin over the last few quarters.

In a positive development, the dividend payout has been increased from 25-30% to 30-40%. This will certainly help the company to reduce the excessive cash on its balance sheet. However there is still no clarity on how the management will deploy the cash in the future.

In our March Stock Select report we had upgraded Infosys from 'Hold' to 'Buy'. This was done keeping in mind the improving fundamentals and the attractive valuations that the stock now trades at. We maintain our 'Buy' view on the stock.

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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