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Infosys 1QFY08: Not one of dollar dreams! - Views on News from Equitymaster
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Infosys 1QFY08: Not one of dollar dreams!
Jul 11, 2007

Performance summary
  • Topline remains flat on QoQ basis on the back of 1% QoQ growth in blended billing rates and 6.9% QoQ growth in volume.
  • Operating margins contract by 3% QoQ due to rupee appreciation and higher staff costs
  • Higher taxes offset higher other income, thus further impacting the net profits
  • Management revises US dollar revenue and profit guidance upwards, rupee guidance downwards for FY08

Consolidated financial snapshot
(Rs m) 4QFY07 1QFY08 Change
Sales 37,720 37,730 0.0%
Expenditure 25,750 26,890 4.4%
Operating profit (EBDITA) 11,970 10,840 -9.4%
Operating profit margin (%) 31.7% 28.7%  
Other income 1,190 2,530 112.6%
Provision for investments (10) -  
Depreciation 1,450 1,440 -0.7%
Profit before tax 11,720 11,930 1.8%
Tax 270 1,140 322.2%
Minority interest 10 -  
Profit after tax/(loss) 11,440 10,790 -5.7%
Net profit margin (%) 30.3% 28.6%  
No. of shares (m) 571.2 573.3  
Diluted earnings per share (Rs)*   72.1  
P/E ratio (x)   28.0  
*On a trailing 12-month basis

What is the company’s business?
Infosys is India’s second largest software services exporter and offers a bouquet of services including software development (21% of revenues), maintenance (29%), IT consulting (4%), package implementation (18%), products (4%) and BPO (5%). The company has been one of the pioneers of the much acclaimed ‘Global Delivery Model’ and its management is acclaimed for corporate governance practices and has been a source of competitive advantage for the company in its rapid growth over the past years.

What has driven performance in 1QFY08?
Stagnant billing rates, rupee appreciation impact topline: Against an average rate of around 2% QoQ rise over the past few quarters, Infosys recorded a lower 1% QoQ rise in blended billing rates in 1QFY08. However, the volume growth at 6.9% YoY was a tad higher than what was recorded in the previous quarter (4QFY07). The company’s topline was largely impacted by the substantial rise in the value of rupee against the US dollar. As per the management, the rupee appreciation took away Rs 2.9 bn off the company’s 1QFY08 revenue. As such, if the rupee were to be stable against the US dollar during the quarter, the company would have grown its topline by around 8% QoQ against the flat growth that it has recorded actually.

  4QFY07 1QFY08  
  Rs m % of total Rs m % of total Change
Development 8,034 21.3% 7,395 19.6% -8.0%
Maintenance 10,712 28.4% 11,130 29.5% 3.9%
Re-engineering 566 1.5% 755 2.0% 33.4%
Package implementation 6,940 18.4% 6,942 18.4% 0.0%
Consulting 1,622 4.3% 1,849 4.9% 14.0%
Testing 2,754 7.3% 2,830 7.5% 2.8%
Engineering services 604 1.6% 528 1.4% -12.5%
Business Process Management 1,961 5.2% 2,037 5.4% 3.9%
Other services 3,093 8.2% 3,056 8.1% -1.2%
Total services 36,287 96.2% 36,523 96.8% 0.7%
Products 1,433 3.8% - 3.2% -100.0%
Total revenues 37,720 100.0% 36,523 100.0% -3.2%

On analysing the performance based on service lines, it becomes clear that, like the previous few quarters, there has been a gradual and constant shift towards high-end services like consulting, testing services and business process management in 1QFY08 as well. These services now form almost 38% of Infosys’ consolidated revenues. Coming to business verticals, the transportation and logistics vertical stole the limelight during this quarter by recording a growth of 28% QoQ, while the contribution from the BFSI segment remained at 36% of the consolidated revenues (degrowth of almost 2% QoQ).

The company added a net of 3,730 employees during the quarter and the attrition rates also remained stable at 13.7%. This is a positive as over the last few quarters, Infosys was struggling to control its attrition levels. On the client side, the company added 35 new clients and the total clientele now stands at 509 as against 500 at the end of March 2007. The contribution from the top 10 clients came down from 33.4% in 4QFY07 to 32.3% in 1QFY08.

Higher costs, rupee dent’s margins: Infosys recorded a 300 basis points (3%) contraction in its operating margins during 1QFY08, mainly due to higher staff costs (as percentage of sales). The company had undertaken a wage hike for all its employees (offshore and onsite) during 1QFY08, which showed in the higher staff costs during the quarter. Though the selling expenses have declined 24% on QoQ terms, corresponding hikes in general expenses (10% QoQ) coupled with hikes in wages were enough to send the operating margins for a toss. The rupee’s appreciation against the US dollar also had its negative impact on the company’s operating margins during the quarter. On an overall basis, the management expects the operating margins to contract by nearly 2% YoY in FY08. Our current estimates for the company already include a 1.8% decline in operating margins for FY08.

Higher tax outgo offsets higher other income: Infosys recorded a 113% QoQ jump in other income mainly due to higher interest income on deposits as interest rates have sky rocketed (Infosys has a cash balance of Rs 51.3 bn as on 30th June 2007) and forex gains, which was a result of an aggressive hedging policy. Indian IT companies, which mostly used to hedge only 50% of their receivable earlier, are now hedging almost 65% to 70% due to sharp and unanticipated appreciation in rupee.

As for Infosys, the substantial rise in other income was completely offset by 322% QoQ rise in taxes and the effective income tax rate also rose to 9.6% as against 2.3% in 4QFY07. One should also note that Infosys reversed Rs 510 m of tax provisions for earlier years. If this were not done, then the bottomline would have fallen by 10.2% on QoQ basis rather than the reported figure of 5.7%.

What to expect?
At the current price of 1,950 the stock is trading at 14.6 times our estimated FY10 earnings. The management has revised its rupee guidance downwards and the revised EPS estimate for FY08 stands at Rs 79 as against Rs 81, which was given under the earlier guidance in April 2007. Against this, our estimates indicate of an EPS figure of Rs 86 for the fiscal. While the quarter brings to reality investors’ fears of suppression in operating profitability levels of the company, like its peers in the Indian market, we maintain our view that the margins will continue to be under pressure in the future as well.

This will be on account of consistent rise in salary costs, as a way of attracting and retaining the right kind of talent as competition intensifies across the spectrum. The uncertain moves of the rupee will also be a thing to look out for in the future. However, as we have maintained in the past, improving revenue productivity, leverage from past sales and marketing initiatives, as also aggressive move towards offering high value services should more than negate the demons of rising costs and currency volatility in the long term. On that note, we maintain our positive rating on the stock from a 2 to 3 years perspective.

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