The return on Equity for Infosys is expected to increase from 20.7 percent in FY17 to 24.3 percent in FY20 while for TCS, the RoE is expected to increase marginally from 33.5 percent in FY17 to 34.8 percent in FY20.
Increase in sub-contracting expenses and localization have impacted both Infosys and Tata Consultancy Services (TCS) in their Q4FY19 margin performance but both the giants reported a steady set of revenues.
Infosys reported 2.4 percent QoQ growth in revenue but margin at 21.4 percent was below expectations of 22.2 percent. TCS also reported revenue growth of 2.4 percent QoQ though the EBIT margin of the company was marginally down at 25.2 percent against expectations of 25.7 percent.
TCS has over the years outperformed Infosys for two basic reasons -- higher sales growth and higher margins. TCS continues to command a higher margin through sales growth has become similar.
Infosys is aggressively investing in people, localization and its sales force to achieve high growth in revenues. For FY20, Infosys guided for a constant currency revenue growth between 7.5 percent and 9.5 percent but we believe the company will surpass its guidance for sales similar to its recent past.
Total TCV for Infosys has been increasing quarter after quarter and now stands at $6.3 billion for the year 2019. TCS and Infosys, both have grown at the same pace in revenues this quarter (19.1 percent YoY for Infosys and 18.5 percent YoY for TCS), though TCS TCV is much higher than Infosys as of now.
For TCS, the guided margins is in the range of 26 to 28 percent range, but it looks unachievable in near term considering that the quarter end margin stood at 25.2 percent only.
Infosys’ margin too has slowed and is at 21.4 percent. But for Infosys margin appears set to rise from hereon. Management too is suggesting that the planned investments have started yielding benefits and that FY20 would be a year of operational efficiencies across the business. Also, once the compensation system gets into force properly, the high attrition should also get arrested.
As revenue growth differential in both the companies has already narrowed, decreasing EBIT margin differential will also narrow the gap in valuations of both the companies. The return on Equity for Infosys is expected to increase from 20.7 percent in FY17 to 24.3 percent in FY20 while for TCS, the RoE is expected to increase marginally from 33.5 percent in FY17 to 34.8 percent in FY20.
At the current prices, Infosys trades at 18.1 times FY20 earnings while TCS trades at 21.4 times FY20 E EPS. We opine, the valuations gap to narrow over the period of next two years as margins pick up for Infosys.
Currently what is worrisome is the macro environment as spending cuts by clients will be a big challenge if the global growth slowdown happens. This quarter, both the companies’ management agreed that the macro environment remained challenging and may pose some slowdown in clients’ budgets.
Management of Infosys sited challenges across BFS segment especially in the capital market segment and manufacturing (which includes Automobiles).
TCS though remained a bit more confident on the segment. TVC wins in the next quarter is a key trackable as any dent on revenues of companies will trigger estimate downgrade.
(The author is Vineeta Sharma, Head of Research at Narnolia Financial Advisors Ltd.)Disclaimer: The views and investment tips expressed by investment experts on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.