Expect Infy to cut dollar revenue guidance to 7-8%: IIFL

Due to the weak global demand environment and adverse cross-currency movements, Sandeep Muthangi of IIFL Institutional Equities says IT major Infosys may cut its dollar revenue guidance for the year.

Infosys currently expects 10% growth in revenue in dollar terms, but Muthangi believes it will actually come in around 7-8%. “Given the very sharp growth rate needed and the lackluster demand environment, they will be downgrading the yearly guidance to more reasonable number somewhere around 7-8% at the top end,” he told CNBC-TV18. He goes on to say that he doesn’t expect to see any valuation derating or downgrades from analysts if Infosys goes ahead and cut FY13 guidance. This is because he expects the company to announce massive hikes to their rupee growth guidance and their rupee EPS. “I expect the EPS to be upgraded from the guided range of about Rs 160 to about Rs 180 this quarter,” he added. Last quarter, the market was hurt by Infosys’ guidance numbers, which were below NASSCOM’s expectations. NASSCOM forecasts 11-12% growth this financial year, and the street did not take it lightly that India’s leading IT services firm expected to grow below that. Meanwhile, Muthangi says TCS is expected to grow 4.5% in constant currency in Q1, and that dollar revenue guidance will be 14%. He believe IT firms can post revenue growth in the mid-teens, but only over the medium term. Below is an edited transcript of his interview with Udayan Mukherjee and Mitali Mukherjee. Also watch the accompanying video. Q: Before we talk of the results, there has been a buzz in the market that Infosys might go in for a buyback. Is it in the expectation radar? A: We don’t comment on speculation rumor. Obviously there has been no announcement from the company management on the buyback, so I will leave at that. Q: Have you guys scaled on dollar revenue guidance expectations or do you expect the management to? A: On the dollar revenue, the guidance this quarter is about 1% in dollar terms, but they will have to battle cross currency headwinds during the quarter. Infosys will have lesser cross currency headwinds because of lower exposure to emerging markets, so we expect about 0.5% or 50 basis point headwinds from the cross currency. We are estimating Infosys to deliver about 0.5% growth in dollar terms and 1% growth in constant currency terms. The real issue will be whether they will be downgrading the yearly guidance or not. For the year they have guided about 10% year on year revenue growth in dollar terms, but as the cross currency will take about 1%, that would technically bring down the revenue guidance to about 9%. But then there is another issue which I believe is the very sharp growth that they expect during Q2 and Q4; the arithmetic would turn out to be about 4.8% growth every quarter from Q2 to Q4. I am a bit more conservative than that. I assume that given the very sharp growth rate needed and the lackluster demand environment, they will be downgrading the yearly guidance to more reasonable number somewhere around 7-8% at the top end. Q: What ramifications would that have for the kind of valuation band Infosys has traditionally enjoyed? If indeed it comes to the yearly guidance being downgraded as you suggest, what do you think happens to the valuations that Infosys has traditionally enjoyed? A: That’s an interesting question because this year we have another big tailwind for Indian IT vendors. Even though they will downgrade the yearly dollar guidance, they are going to upgrade the rupee EPS and the rupee revenue guidance massively. This quarter itself rupee has depreciated by about 8% against the dollar. This is a huge tailwind for the margins and for the EPS. So what will happen is the guidance for the margin is about 200 bps down quarter on quarter, but I estimate the margins will actually be up 50 bps and that will drive massive EPS upgrades from the company also. I expect the EPS to be upgraded from the guided range of about Rs 160 to about Rs 180 this quarter. So, perhaps I don’t see a valuation de-rating on the back of a revenue dollar guidance downgrade itself. I think that is in the expectations also. So most of the consensus is anyway building in and I have been building in about an 8% revenue growth since they have given the guidance during Q4 itself. So, per se I don’t think this downward revision from Infosys will lead to a downgrade of estimates from analysts. Read on to find out IIFL's views on HCL Tech.. _PAGEBREAK_ Q: The fact that the overall dollar revenue guidance which is the measure of how the business is doing is being scaled down progressively or is it a PE multiple worked on EPS which is growing up because of the currency factor, which one is the market more likely to focus on? A: I think the issue is much deeper and broader. I believe the demand conditions for the Indian IT industry have changed fundamentally after the 2008 slowdown and the recovery. In some of the services which have been off shored for the past 10-12 years we are seeing increase in commoditization that is happening, so there will be the usual margin pressure and the price pressure, etc in certain set of services and also On the other hand, we are also seeing Indian IT vendors taking increasingly complex contracts. So we are hearing of very large infrastructure outsourcing deals, very large deals where two or three service lines are going to be used. These are fundamentally different kind of contracts that Indian IT vendors are entering into. So I believe that from a medium term to long perspective, the challenge for Indian IT vendors is to somehow manage the commoditization that is happening in a part of their services which could be through more delivery levers, more automation and things like that. The other opportunity is to get into these new larger services which are a much bigger opportunity for the Indian IT vendors. So when I look at the Indian IT industry over the medium term, I still believe that mid-teens kind of a revenue growth is still possible because frankly the market opportunity is quite huge once they address these challenges. The real issue then is about how profitable will the new business be. My belief is that again you have to manage the commoditization versus some of the opportunities that these new probably better priced contracts will give you. So profitability wise also I don’t see any major headwinds for the Indian IT industry over the next two to three years. so I believe the valuations per se should be sustainable, but the challenge is about which company will again grow the topline faster because I think that enables huge margin levers for Indian IT companies. Q: It’s not just Infosys but the big one, TCS, also reports tomorrow. What are your expectations there?
A: this is the first time TCS is reporting on the same day as Infosys. I expect TCS to continue to grow faster. They have won a lot of deals over the past two-three years, so the ramp ups on those deals are quite strong. Also this quarter we will see the ramp up on the very large insurance BPO deal that they have won, so there are enough tailwinds for TCS to give a fairly strong revenue growth.
Management’s indications have been somewhere around 4%. I expect TCS to grow about 4.5% in constant currency terms. But that said, TCS gets a huge amount of revenue from emerging markets, India, Latin America, etc, so that will take about 1.8% of the revenues. So I expect TCS to be somewhere around 2.5-3% revenue growth. TCS has also given a wage hike so their margins most likely will not improve in the quarter. Q: There was a minor flutter couple of weeks back on suggestions that the TCS management was also talking about a cool off in volume growth, which they subsequently clarified. Do you think that there is going to be any such problem laid out by TCS?
A: I think a misquote was carried by some of the media agencies, which was a direct copy paste of a statement from the annual reports, so I think that led to this whole furor. I haven’t seen management sharply revising downwards or sharply commenting on a demand slowdown or things like that.
Management has been maintaining the stance that this year is going to be a bit slow, which is what even we are building into our estimates. Last year TCS grew about 25% in dollar terms, and this year we expect TCS to grow somewhere around 14% dollar terms. That is massive slowdown that we have already factored in. This downward revision happened close to six-seven months ago and since then we haven’t downgraded any of our revenue estimates and I don’t think there is reason enough now to downgrade the estimates. Q: The interesting one will be HCL Tech where numbers have been strong but there has been underperformance, basically tied in from the time when the promoter chose to sell some stake and there was market chatter about how a lot of the core responsibilities were getting delegated to others. Would you be worried at all on HCL Tech’s behalf?
A: There are two ways of looking at it. It is fairly okay to see the promoter or the CEO stake sale as a bit of a negative because sometimes these things do happen. But we also have to remember that it was the first time in their history where the company has clearly clarified on a speculation or a comment, so they are pretty serious about what they said about the CEO staying with the company. That is what in fact Vineet Nayyar has also clarified.
The other thing with respect to HCL Tech is they have again won a lot of deals over the past two-three years and it is during these times when typically aggressive vendor has the opportunity to penetrate some new accounts and win a lot of market share. So I think that is the key thing that I would focus on with respect to HCL Tech, which is basically the amount of market share that they have gained and kind of revenue traction that they are experiencing. From that point of view, I am not overly worried with HCL Tech.