Investors will have to be content with single-digit earnings although the hefty dividend payout could limit downside for the stock
Hello and welcome back, you are listening to Moneycontrol my name is Rakesh and its time for our story of the day. And today in the wake of Infosys’s 4th quarter numbers, we're going to be concentrating on Infosys and what those numbers mean for the company. This is story of the day and you are with Moneycontrol.
Infosys’s 4th quarter numbers were on unexpected lines, although the guidance for financial year 2019 points to accelerated investments. And while that is essential for the company to adapt to a fast changing technology environment, it good depress near term earnings, goes on to write Madhuchanda Dey for Moneycontrol. The sudden disposal of recently acquired Panaya and Scava only adds to the controversy that has dogged these acquisitions. It also indicates that Team Salil Parekh is charting its own path with the founders blessing, that is Narayan Murthy’s blessings and adopting a service led growth model as opposed to his predecessor that is Vishal Sikka's strategy of emphasizing on products. Infosys share holders will have to be content with single digit earnings growth for a while although the hefty payout could limit downside for the stock.
Let’s take a quick at what the numbers themselves had to say about this quarter. There was no negative surprise so to speak, it was very much in line with the expectations laid out. Q4 revenue were at 2805 million dollars or 18083 crore rupees, EBDA about 4930 crore rupees or 27.3% compared to quarter 3 of financial year 2018, that's the rise of just about. 2%, because it was about 27.1 % the previous quarter.
Here’s a podcast on Infosys’s Q4 earnings and how the numbers stack up...
One of the major takeaways from the quarter earnings report was ofcourse the fact that there were lukewarm results, but the company’s decision to lower its operating margin band to 22 to 24% for 2018-2019 disappointed investors and suggested that India's second largest software services exporter continued to struggle to get more yield from it’s traditional outsourcing business where profitability is dwindling. It may also be that Vishal Sikka’s resignation has had an impact because both growth and profitability in 2017-2018 have suffered and were lower than what the company managed in 2016-2017. The lower margin guidance for financial year 2019 and the relatively soft revenue forecast have obviously not gone down well with investors. In premarket trading on the Nasdaq, Infosys shares were trading down nearly 7% and that was the story reflected when markets opened today where Infosys was trading down about 6% in early morning trade. More than that later.
In the January-March period, Infosys reported a 1.8% sequential rise in dollar revenue to 2.8 billion dollars, allowing it to end fiscal year 2017-2018 with 10.94 billion dollars in revenue, which was a 7.2% year-on-year growth and 24.3% operating margin. If you want to put that in constant currency terms, Infosys managed a 5.8% growth which was well lower than industry body Nasscom’s estimate of 7.8% growth last year. The company also reported a 7.4% dollar revenue growth or 8.3% in constant currency terms and 24.7% operating margin in 2016-2017.
In the current fiscal year that is 2018-2019, the company expects to grow 6 to 8% in constant currency terms and expects 7 to 9% dollar revenue growth and an operating margin of 22 to 24%. Net profit meanwhile has declined 28.2% to 571 million dollars in the March quarter from 796 million dollars in the October-December quarter as Infosys booked a 225 million dollar gain on reversal of income tax expenses in the United States. This decline was obviously predicted well. A Bloomberg survey of 26 analysts had forecast Infosys to report revenue of 2.79 billion dollars or 18116 crores in the quarter.
The analyst estimated the company to report a net profit of 569.89 million dollars in the period and indeed it was a close 571 million dollars, when it was reported. So what does SEO Salil Parekh have to say? He said in a post earnings conference, “In Q4 we had strong revenue growth and happy with our performance. In terms of our guidance for 2018-2019 given the external factors and the internal factors, we have come out with the 6 to 8% constant current guidance, it's a very stable good outlook for the market that we see today”.
The company also said that the continued challenges in retail due to the Amazon effect, a softness in manufacturing and the trend of insourcing by clients increasingly adopting capital solutions was impacting financial service clients in North America. Management sounded optimistic on verticals like energy and utilities as well as Telecom. Deal wins have remained healthy. There were 10 large deals worth 905 million dollars during the march quarter, which took over all addition in the year to 3 billion dollars.
How does it compare with the other big software solution providers and what indeed is the outlook for the industry? Many analysts believe that both TCS and Wipro could lower the profitability outlook for the current fiscal year. TCS declares its earnings on the 19th of April, while Wipro reports its Q4 and full year earnings on the 25th of April. So Infosys lowering its profitability outlook for the current financial year is indeed a sign of worry for all companies, according to many analysts and industry executives who say that the core services business is falling apart as companies struggle to earn more from offering newer solutions.
In a note on the 11th of April Keith Bachman, an analyst with BMO capital markets went on to say that the decline that we see in FY 19 not a one time event and represents a new normal. He went on to say, “ Our read through is that margins will likely be under pressure for the IT services sector broadly and is also evidenced by ACN’s margin performance / guidance in the February quarter.” With ACN he of course meant Accenture PLC which while declaring its 2nd quarter earnings reported an operating margin of 13.4% narrowing 30 basis points from the year ago period.
There are many reasons being proposed as to why there is a continued pressure on profitability. One of them is that all IT outsourcing firms have seen an increase in wage bill, on account of hiring locals in overseas markets including the US and Europe as opposed to hiring Indian hires. Secondly buying spree to remain relevant. Many of these companies have started acquiring companies which are focused on newer technologies and that obviously means that their overall profitability will be challenged. Wipro for example between April 2016 and December 2017 has gone on to acquire 5 companies, spending over a billion dollars and that obviously had an impact on is operating margin which fell by over 200 basis points. And 3rd and perhaps common to all these companies is the intense pricing pressure on commoditized deals, which still accounts for about 3/4ths of the total revenues at many of these companies.
In this cut throat environment companies have obviously face challenges which have resulted in profitability declining quite as much as it has. And on the question of if it is fool hardy to write off this sector, the answer is an absolute yes, because still there aren't as many industries that can claim having 22 to 23% profitability. So IT outsourcing should also be brought under that perception, rather than the inflated sense at we have seen so far within the industry. So the decline in profitability should be understood as the new normal, is what to word on the street is.
So what next for Infosys in specific? It has chalked out plans to substantially ramp up digital revenue from the current level of 2.8 billion dollars and is looking to spend more to move up the learning curve. Increasing the share of digital, lies in the core of the strategy as the company sees the market size of this fast growing piece in the range of 180 to 200 billion dollars. The company also aims to spend more to automate its traditional services, reskill employees to be future ready, increase localisation in the core markets like the US, UK, Australia that would warrant more investment hiring as well as training and backend infrastructure and finally revving up its sales engines to bag more high value deals. Incidentally, in view the high attrition rate the company has also set aside $10 million for employees.
How have we seen the mark of this new management? Well, it’s not digressing totally from the transformation path that was started by Vishal Sikka, although Salil Parekh is making his own modifications to it. So it's not entirely being chopped off but there are certain tweaks to the Sikka train. The fire sale of recently acquired businesses like Scava, April 2015 for 120 million dollars and the much controversial Panaya, which was bought in February 2015 for 200 million dollars are prime examples of this. The management mentioned negligible contribution from these businesses and has recognised an impairment loss of 118 crore rupees, in respect of Panaya for the quarter. The corresponding write down in the investment value in the standalone financial statements of Infosys is 589 crore rupees. The haste in disposing of both Scava and Panaya leaves many questions unanswered.
And finally how have the market reacted? Shares of Infosys have been down nearly 3% in morning to late afternoon trade and it is the top loser on the benchmark Sensex in the wake of it pruning its guidance on the margin for FY 19. Well it did lose by 6% like I said in early morning trade, but as I speak it is spared some losses and is trading 3.11% down at about 1135 rupees.Is Infosys the first in the wave of companies showing decline profitability and a lower margin guidance for FY 19? We’ll simply have to wait to find out, as we dive deep into earning season. Like I said earlier Wipro reports it’s Q4 and full year earnings on the 25th of April, TCS declares its earnings on the 19th of April. To find out how this story evolves you’ll just have to stay with us on Moneycontrol. This has been our story of the day looking at Infosys’s quarter earnings and whether or not this guidance is going to be the new normal for the near future. Until the next time I see you, this is me Rakesh saying thank you for joining us on behalf of everyone here at Moneycontrol.