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Infosys: Underpromising and overperforming

Oct 10, 2003

Infosys Technologies has reported strong September quarter results with topline and bottomline growing by 5% and 8%, respectively. Notably, the company has improved upon its operating margins for 2QFY04 by 100 basis points. However, for 1HFY04, the margins have declined by 360 basis points.

Financial performance: A snapshot
(Rs m)1QFY042QFY04Change1HFY031HFY04Change
Sales 10,820 11,348 4.9% 16,442 22,167 34.8%
Other Income 324 443 36.5% 424 767 80.9%
Expenditure 7,337 7,563 3.1% 10,460 14,900 42.4%
Operating Profit (EBDIT) 3,483 3,784 8.7% 5,982 7,267 21.5%
Operating Profit Margin (%)32.2%33.3% 36.4%32.8% 
Interest - -   - -  
Depreciation 443 623 40.8% 867 1,066 22.9%
Profit before Tax3,3653,6047.1%5,5396,96925.8%
Extraordinary items (64) (2)  (238) (66) 
Tax 520 600 15.4% 875 1,120 28.0%
Profit after Tax/(Loss) 2,781 3,002 7.9% 4,426 5,783 30.6%
Net profit margin (%)25.7%26.5% 26.9%26.1% 
No. of Shares 66.2 66.2   66.2 66.2  
Diluted Earnings per share* (Rs)168.0181.4 133.7174.7 
P/E Ratio (x)  25.1    26.0  
(* annualised)      

The revenue growth for the September quarter has been brought about by growth on both the volumes and pricing fronts. While offshore volumes increased by 10.5% sequentially, the growth in onsite volumes has been 2.4%. On the billing rates front, onsite rates improved by 1.4%, the improvement in offshore rates was at 2.3%, sequentially. This signifies some signs of stability on the pricing front.

Revenue streams: Declining high-end services’ revenues…
 Rs m% of totalRs m% of totalChange
Development 3,008 27.8% 2,860 25.2%-4.9%
Maintenance 2,911 26.9% 3,586 31.6%23.2%
Re-engineering 725 6.7% 670 5.9%-7.6%
Package implementation 1,461 13.5% 1,430 12.6%-2.1%
Consulting 476 4.4% 386 3.4%-19.0%
Testing 476 4.4% 681 6.0%43.0%
Engineering services 281 2.6% 238 2.1%-15.3%
Other services 1,093 10.1% 1,180 10.4%8.0%
Total services 10,430 96.4% 11,030 97.2%5.7%
Products 390 3.6% 318 2.8%-18.4%
Total revenues 10,820 100.0% 11,348 100.0%4.9%

Amidst all the positives, there are some aspects of the company’s quarterly performance we would like to comment upon. Apart from decline in development revenues, those from high-end services like reengineering, package implementation and consulting also dropped in 1QFY04. Revenues from the product business (Finacle) also declined sequentially in 2QFY04. This is concerning due to the fact that Infosys has been focusing its efforts in increasing its presence in these high-end services that have been the domain of global technology majors. In this regard, the company has invested heavily on its distribution and marketing fronts. Thus, improvement in the performance of these new service offerings assumes importance for Infosys. However we would like to point out that in the June quarter the company had reported improvement in almost all its service offerings and to that extent the current performance might not be indicative of a trend.

On the margins front, reduced levels (as percentage of revenues) of software development and selling and marketing expenses have helped the company to improve upon its operating margins for the September quarter. Also, increase in offshore efforts and decline in sub-contracting charges have helped towards the growth in margins. It is to be noted that Infosys has been consistently increasing its efforts on the scalability front by refurbishing its selling and marketing infrastructure adding to its human resource base. Thus, going forward, the company is likely to realize scale benefits from these investments.

The profitability of Infosys has improved substantially in 2QFY04 and 1HFY04. Apart from growth in revenues, large gains accruing due to premium of forward contracts has helped the company to increase its profits. On the human resource front, Infosys continues to scale-up at a rapid pace and has hired 2,025 employees in 2QFY04 (12% sequential growth). This is in anticipation of increased demand from its existing and new clients going forward. However, one cause of concern for the company is that the attrition rate (9.1%) has increased in this quarter (7.9% in 1QFY04). In the September quarter, the company added 29 new clients, including Telstra where the contract is worth US$ 50 m for a five-year period, and involves software development and maintenance services.

At the current price of Rs 4,548, the stock is trading at a P/E multiple of 26x its annualized 1HFY04 earnings. The management has revised its EPS estimate to Rs 178 as compared to Rs 168 earlier (in 1QFY04), a growth of 24% over FY03. At this revised FY04 earnings guidance, the P/E multiple for the stock comes to 25.5x. Stability on the pricing front is likely to give Infosys the leverage of focusing its efforts on the volumes front. The management has been talking about large-size deals to be in the pipeline. It still remains to be seen when this expectation of large deals flowing Infosys’ way turns into reality. However since the stock has run up significantly in the last two quarters, after the earnings upgrades, the risk profile (in terms of heightened expectations) has risen. At the same time we would also like to point out that, since the management has consistently delivered in the past, long-term investors need not be too worried about short-term market movements.

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