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Infosys: Three cheers! - Views on News from Equitymaster

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Infosys: Three cheers!

Oct 12, 2004

Infosys has announced strong results for the second quarter and half-year ended September 2004. Also, the company has revised upwards its FY05 revenue and EPS guidance. The revised FY05 EPS estimates now stand improved from Rs 62.5 per share to Rs 67.0 per share, YoY growth of around 44%.

Financial performance (Consolidated): A snapshot…
(Rs m) 1QFY05 2QFY05 Change 1HFY04 1HFY05 Change
Sales 15,174 17,493 15.3% 22,465 32,667 45.4%
Expenditure 10,281 11,883 15.6% 15,146 22,164 46.3%
Operating profit (EBDITA) 4,893 5,610 14.7% 7,319 10,503 43.5%
Operating profit margin (%) 32.2% 32.1%   32.6% 32.2%  
Other income 157 296 88.5% 751 453 -39.7%
Depreciation 525 606 15.4% 1,086 1,132 4.3%
Profit before tax 4,524 5,300 17.1% 6,985 9,824 40.7%
Extraordinary items (0) (1)   (66) (1)  
Tax 641 826 28.8% 1,120 1,467 31.0%
Profit after tax/(loss) 3,883 4,474 15.2% 5,799 8,357 44.1%
Net profit margin (%) 25.6% 25.6%   25.8% 25.6%  
No. of shares 266.6 267.9   266.6 267.9  
Diluted earnings per share* (Rs) 58.0 66.8   43.3 62.4  
P/E ratio (x)   25.7     27.5  
(* annualised)            

What is the company’s business?
Infosys is India’s second largest software services exporter and has a presence in a vast array of offerings, which include software development (25% of revenues) and maintenance (29%), IT Consulting (3%), package implementation (15%), products (3%) and BPO (2%). Infosys’ management is acclaimed for its 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?
  • Sales: Strong sequential growth in the topline in 2QFY05 was a result of improvement in both volumes and billing rates. As a matter of fact, billing rates for onsite and offshore services improved respectively by 1.6% and 0.7% QoQ. Also, while onsite volumes grew QoQ by 7.1%, offshore volumes were up strongly by 16.7%. Higher volumes have led to Improvement in utilisation levels (excluding trainees). However, the fact that Infosys has added almost 5,000 employees to its base has led to utilisation (including trainees) drop to 71% (73% in 1QFY05).

    Revenue streams: BPM and products score!
      1QFY05 2QFY05  
      Rs m % of total Rs m % of total Change
    Development 3,960 26.1% 4,391 25.1% 10.9%
    Maintenance 4,370 28.8% 5,108 29.2% 16.9%
    Re-engineering 880 5.8% 1,137 6.5% 29.2%
    Package implementation 2,276 15.0% 2,641 15.1% 16.1%
    Consulting 516 3.4% 525 3.0% 1.7%
    Testing 804 5.3% 997 5.7% 24.0%
    Engineering services 288 1.9% 350 2.0% 21.4%
    Business Process Management 319 2.1% 420 2.4% 31.8%
    Other services 1,396 9.2% 1,417 8.1% 1.5%
    Total services 14,810 97.6% 16,986 97.1% 14.7%
    Products 364 2.4% 507 2.9% 39.3%
    Total revenues 15,174 100.0% 17,493 100.0% 15.3%

    Another important facet of Infosys’ topline growth in this quarter is that revenues from development services have growth sequentially by 11%. While this is lower than the sequential growth of 15% in 1QFY05, it indicates an increasing focus towards discretionary spending. Simply put, it means that clients are demanding new software development, something that has taken the backseat during the years of slowdown in technology spending. And this is a good sign for Infosys’ future growth. The company continues to witness strong growth from BPO services (Progeon) and revenues from the same have grown sequentially by 32% (24% in 1QFY05). Infosys added 32 clients in the quarter and the active client base now stands at 431.

  • Operating margins: Despite adding a large number of employees to its payrolls, Infosys has managed to keep its operating margins almost at 1QFY05 levels. This is seemingly a result of the fact that the company is hiring more at the ‘freshers’ level, where people come at a lower marginal cost than experienced people. This is well indicated in development expenses (as percentage of sales) in 2QFY05, which, despite such a large addition to manpower, have actually reduced from the 1QFY05 levels. However, a lower utilisation (including trainees) and rise in selling and administrative costs has slightly impacted margins in 2QFY05.

  • Net profits: Strong growth in other income has also, to an extent, helped Infosys report robust improvement in its net profits for 2QFY05, on a sequential basis. This is largely a result of foreign exchange gains (Rs 64 m) that Infosys has earned in 2QFY05, against exchange losses (Rs 139 m) in 1QFY05. This is seemingly a result of depreciation of the rupee vis-à-vis the US dollar. It must be noted that since a large part of Infosys’ revenues (98.3%) are from exports and that a large part of these exports are in US dollar terms, any depreciation in the rupee’s value benefits revenue and earnings growth.

    Performance in the recent past…
      3QFY04 4QFY04 1QFY05 2QFY05
    Sales growth (%, QoQ) 9.1 7.4 12.4 15.3
    Development expenses (% of sales) 52.2 52.4 53.1 53.0
    Selling expenses (% of sales) 7.5 6.8 6.9 7.0
    Operating margins (%) 32.9 33.3 32.2 32.1
    Profits growth (%, QoQ) 9.1 2.0 15.8 15.2
    Employees (Nos.) 21,809 25,634 27,939 32,949
    Utilisation (%) 73.1 70.2 73.4 71.4
    Revenue per employee (Rs m) 0.6 0.5 0.5 0.5
    Revenue per client (Rs m) 34.6 33.3 36.2 40.6

    What to expect?
    At the current price of Rs 1,718, the stock is trading at a P/E multiple of 27.5 times annualised 1HFY05 earnings and 25.6 times expected FY05 EPS of Rs 67 per share. The board of the company has recommended an interim dividend of Rs 5 per share (Rs 3.6 in 2QFY04).

    Apart from upward revision in the EPS guidance, Infosys’ management has upgraded its FY05 revenue projections from 39%-40% to 47%-48%. This upbeat guidance is based on the management’s view that the company is likely to gain from the increasing move towards outsourcing as global corporations vie for increasing their competitiveness. Also, the fact that Infosys has managed to increase the number of its large size clients, points to a positive direction. As a matter of fact, the company’s US$ 10 m+ and US$ 40 m+ clients have increased respectively to 31 and 7 in 2QFY05 (from 27 and 5 in 1QFY05).

    While valuations look stretched from a medium term perspective, investors would do well to have a long-term investment in the growth story that is Infosys.


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