Expect 120 bps fall in Infosys' margins in Q3: IIFL Inst

In an interview with CNBC-TV18, Sandeep Muthangi of IIFL Institutional Equities spoke about his reading and outlook for Infosys, which will announce its third quarter numbers on Friday.

Below is a verbatim transcript of the interview:

Q: Some people are hoping that Infosys will surprise on the way up tomorrow after four quarters? What are the chances of that happening?

A: My expectation for Infosys is pretty weak. This quarter is usually weak for Indian IT.

There are two reasons. Firstly, there are lesser working days. Secondly, you have furloughs or temporary suspensions of work. This used to happen primarily for the manufacturing clients, but this time around we have seen them happening even for the banking, financial services and insurance (BFSI) clients. A lot of large BFSI clients, which are amongst the top-10 clients of these companies, have such furloughs or temporary suspensions of work because of which, it is difficult to have a good quarter in Q3FY13.

I expect the top four vendours to have a revenue growth of anywhere between 0.5 percent and 2 percent, quarter-on-quarter (QoQ) in dollar terms. It is a pretty weak number.

Infosys particularly also have salary hikes happening this quarter because of which their EBITDA will look probably very weak.

Q: How much do you expect margins to come off?

A: I am expecting about 120 basis points (bps) fall in the margins.

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Q: Any respite from pricing at all in the current quarter?

A: I would not want to classify it as a pricing fall because so far we have not seen any big rate cut based price discounts that were prominent in pre-2008 era.

The realisations of IT companies have been falling. We have seen it happening in the first half for Infosys, Tata Consultancy Services (TCS) for almost all the other vendours.

These are happening for a couple of different reasons. There is definitely a mix change that is happening around the services that these companies do. For Infosys, especially we have seen services, which are not premium services or discretionary services like enterprise resource planning (ERP) etc, growing a bit faster. So that is also contributing to realisation fall. Also there are other services like infrastructure etc, which are leading to some kind of a realisation fall.

So, there are a lot of factors happening because of which the average realisations are falling. I expect that to continue in this quarter.
 
Q: You will be surprised if Infosys did not scale down its organic guidance for the full year, a notch this quarter?

A: Yes, I will be surprised.

The organic guidance is 5 percent year-on-year (YoY) that we are talking of. If they do not scale their organic guidance down then it will be taken positively by the markets. I expect it to be scaled down. This is how the arithmetic works. To get that 5 percent, they need to grow 3.7 percent this quarter and the next quarter. If they do not grow 3.7 percent this quarter -- let us assume they grow 1.5 percent — then the organic guidance has to be brought down to 3.8 percent; that is technical and purely arithmetic.

So depending upon what they do this quarter -- even if they meet the so-called implied guidance of 3.7 percent next quarter -- I think we will see the organic guidance being cut to somewhere between 3.3 percent and 3.8 percent.

Q: Is all of that in the price or do you see more downside from here if your fears come through of a very tepid volume growth in dollar terms and a scale down in guidance?

A: Second half of last year has been fairly weak for the Indian IT vendours. 2012, in general, has been much weaker than 2011. Second half is the time when we saw a lot of these pressures either from Budget, from realisations materialising for Indian IT vendours.

At least, starting into 2013, we do not have very positive indications of a revival of demand growth or anything of that sort. At best, we could expect maybe a repeat of 2012. It is a fairly weak demand environment. I do not think the valuations of at least some of the Indian IT vendours have corrected to reflect the slowdown in the demand environment.

Primarily from that point of view, we can have a fairly weak year of returns for both, Infosys and TCS.

Q: TCS will follow on Monday, do you expect the numbers to be marginally better than Infosys as it has been for the last many quarters?

A: I expect so. TCS has built a fairly diversified set of clients and services in industries. It has reacted or maybe it was proactive and it benefited from the changed demand environment after 2009. So, it is more diversified play and I think their revenue growth will be better. My expectation is that they will have the fastest revenue growth amongst the Indian IT vendours again.

Q: Where does that leave HCL Technologies and Wipro for the quarter?

A: HCL Technologies also has been doing well. They won a lot of large deals even this year and I expect the ramp-ups to continue. So, I expect HCL Technologies also to have a fairly good revenue growth.

They also have a part of the impact of salary hikes happening. So, last year it was primarily the technical talent, which has these wage hikes. This quarter some of the other management or the senior management will be having their salary hikes. There will be a bit of pressure on the margins for HCL Technologies.

Apart from that, I think they should have a fairly good revenue growth of about 2-2.5 percent.

Historically, if you look at Wipro, second half has been a bit better compared to other IT vendours. So, their results will be better than that of Infosys. However, I expect a revenue growth of about 1.5 percent.