Infosys Results: IIFL sees co guiding to 12% growth in FY14

Sandeep Muthangi, Vice President - Research, IIFL Institutional Equities expects Infosys to guide to 12 percent growth for the next year. He believes that giving guidance is one of the core philosophies of Infosys and this will continue. The company is going to announce its fourth quarter numbers tomorrow.

He sees results to be in line with the guidance. "The implied guidance for this quarter is about 4.1 percent including the acquisition of Lodestone" he said. He told CNBC-TV18 that Wipro and HCL Tech will be above Infosys in his pecking order. Also read: Infosys may guide to 8-9% growth for FY14: Rajgarhia Below is the verbatim transcript of his interview to CNBC-TV18 Q: There has been so much debate that whether Infosys will put out guidance or not. What are the probabilities like? They stop short of giving guidance or they are given something which is in line with the National Association of Software and Services Companies (NASSCOM) guidance for the year?

A: The debate on Infosys’ results has multiple angles now. 1) Given the extent of surprises that have happened both positive and negative over the many quarters in the past. 2) What the actual results will be and then the debate is on whether they will give the guidance or not. Historically leaving the last two years, the guidance has been a bit conservative. So they have outperformed the guidance. So, I think giving guidance is one of the core philosophies of Infosys and they will continue to give guidance. They should give about 12 percent odd growth for the next year. This is based on assuming that the next year, they will do at least as much growth as they have done this year, which is about two percent every quarter. So, if one sees that arithmetic, one will get to a 12 percent growth number for Infosys as far as the guidance is concerned. Anything less than that will be a negative surprise. Again, 12 percent growth means it is only 10 percent organic. It is inline with NASSCOM’s numbers, but it is not very aggressive. That is on their guidance.

Also coming to their results, I expect the results to be inline with their guidance. The implied guidance for this quarter is about 4.1 percent including the acquisition of Lodestone. The pound has started to depreciate a bit, so that will have a bit of impact on the dollar revenue growth. So, knock it off, about 30 bps. I think the revenue growth should be somewhere in the range of 3.7-3.8 percent during the quarter. Again, this quarter is very significant. Given that last quarter was a very momentous one for Infosys, the revenue growth was the fastest among the top four vendors. Last quarter was momentous, but the problem with last quarter is that it was not very broad based. A total of 70 percent of the increment growth was due to its ERP and the banking products business. So, to that extent, there is definitely a bit of uncertainty as to what they will do this quarter. However, given the slight pick up in the environment and the quite decent deal wins for them, I think they should be inline with the guidance. Q: For the FY14 expectations, how would you break it up? Would you say it is going to be an even couple of quarters for them in terms of what they deliver or you think it is going to be bumpy and volatile for Infosys through FY14? A: They are definitely more aggressive now and they are entering into deals like infrastructure services, which we haven’t seen being aggressive for quite some time. So, these deals do give a bit of volatility given that the transition times are fairly less in these deals. Even in the last quarter, one will see and I think one has seen some impact of this happening. So, there will definitely be a bit of volatility, but I would assume that the usual seasonality that we see, the first half will be better than the second half. Situation should prevail in FY14. So, there will be a bit of volatility, but the usual seasonality that we see during a normal year where the first half is better than second half should be what people should be expecting. Q: What can you put out as a reasonable expectation from Infosys in terms of earnings per share that you think they can do and what kind of price this stock can hold through the course of the next few months?

A: This question has multiple angles. We have been talking about revenue growth for some time, but there is also an inherent challenge with respect to the margins, not just for Infosys also for the industry. This quarter itself, they have a couple of headwinds. One is the onsite wage hikes. The management itself has said that because of onsite wage hikes and because of the Lodestone acquisition, integration and consolidation, the margin headwinds are about 130 bps. So, they will have a couple of levers to offset that but that’s a lot of headwinds even in this quarter. Going forward, if one looks at first quarter, one has the usual visas being applied and that’s a big headwind in the first quarter. Second and third quarters, one again comes into the usual wage hikes cycles, etc. There are very few levers to offset that. One can improve the delivery a bit in all these things but as long as the pricing in the inherent revenue productivity of the company doesn’t increase, it is difficult to offset these levers. So, I think that margins, one has to be a bit cautious. Also, next year, the tax rates for these companies will increase because of the additional surcharge – that will be another 100-150 bps of headwind for these companies. I would say that if they give a guidance of 12-13 percent, let's say the guidance is about 12 percent in terms of revenues. The profit growth should be less than that because of the challenges on the margins and on the tax rates. Q: Could some of this margin pressure also be on account of this recent aggression that you are speaking of? They might actually be taking pricing sacrifices to get volumes up to industry leading standards?

A: Let’s break it down. I think for a long time, we have been focusing on this equation. Revenue is pricing in the volumes. Now, this equation doesn’t hold true any longer because there are significant other elements in the business that don’t workout on a simple volume enterprising basis. There are infrastructure services, there are fixed price deals, there are managed services deals, etc - that’s making the business a bit more complicated. So I don’t believe it is a direct price cut to get more volumes. However, other businesses and IT services do have their own challenges in terms of lower profitability and things like that. Since 2008, we have been seeing, a significant change in the behaviour of the clients, so if one looks at lot of these re-bid contracts - a lot of contracts are getting shorted. So if the natural life of the contract was 10 years, it is coming up for annual in five-six years. The client wants to do request for proposal (RFP). So that’s the kind of environment that we are talking of. It need not be a direct pricing cut that the company is offering, but things are a lot more competitive especially on the maintenance side of IT services. I think the competition is quite high. So, these are the couple of challenges that any company will have including Infosys. Infosys is entering in a significant way into other verticals like infrastructure services, etc. So again, some of these verticals or some of these service lines have a different margin profile. Infrastructure services for instance, over the period of the contract, one may see margins averaging to about 20 percent plus levels. But to start with, the margins will be lower because you have a lot of transmission and re-batching and the costs that are involved. So some of these could be short term pressures but I believe that inherent margin challenges for the industry are high. Q: What do you hear from your clients on ownership on Infosys? Last quarter, they benefited because everybody was underweight and Infosys delivered a positive surprise. Do you think the under ownership of the stock got corrected over the last couple of months?

A: Relatively yes. Compared to December, I think under ownership definitely after last results have got corrected. That’s one of the reasons why one saw such a sharp move after the results. I think the under ownership has got corrected relatively compared to December. Q: At this point, is Infosys your top pick from IT? How are you rating that?

A: I prefer companies with cheaper valuations. So I still prefer HCL Tech and Wipro in the pecking order. But in general, I think IT has a couple of tailwinds going into this year rupee being one of the factors and the slight improvement in the demand environment, etc. But Wipro and HCL Tech would still be above Infosys in my pecking order.