Some shocks, no panic: Five takeouts from Infosys results

Doubts about Infosys Technologies will only grow after its first quarter (Q1) results for 2012-13 - about its business model, about its leadership, about its conservatism in using its cash, and about its ability to be a leader in the pack.

There are five takeouts from the Q1 results announced on Thursday.

One, revenue visibility is down, and currency volatility is going to make rupee earnings uncertain. Quarterly guidance has been abandoned.

Two, the management is not going to be stampeded into giving away it cash hoard - now over Rs 20,500 crore. There will be no share buybacks just to please analysts.

Three, margins are coming under pressure. The company is pricing its services according to the customer, but it has not abandoned its high-margin strategy in the pursuit of short-term volumes.

Four, client acquisition is showing no major problems, despite the adverse economic situation. Infy added 51 clients in Q1 of 2012-13, against 26 in Q1 2011-12, and 52 in the last quarter (Q4) of 2011-12.

Five, Europe is the real drag on Infy. In this situation, North America’s share of Infy’s revenues are up to 64.1 percent (from 62.4 percent in March) while Europe’s is down from 23.1 percent to 21.4 percent.

But these are not the market’s takeouts, as evidenced in the near 10 percent drop in Infosys’ share prices after the results were announced. So what is the market looking at?

The market has noted that Infosys has cut its guidance and it profits and margins are under pressure. The year’s dollar guidance is now revenues of “at least $7.343 billion” - a year-on-year growth of 5 percent, lower than the 6 percent guided earlier. Earnings per share (EPS) will rise just 1 percent to $3.03 per ADR. In rupee terms, it will be “at least” Rs 166.46 a share - up 14.4 percent (nothing great, when the rupee has fallen 25 percent over the last year). But this EPS guidance depends on the conversion rate of Rs 55 to the dollar. There could be further shocks if the exchange rates move adversely once more.

Infosys abandonment of its quarterly guidance is a clear indication that revenue visibility is getting worse in an uncertain world economic climate.

The consolidated results for the April-June quarter in dollar terms show a rise of 4.8 percent to $1,752 million over the corresponding quarter of last year, and an actual drop of 1.1 percent over the March quarter’s figure of $1,771 million - which was also the lower end of the first quarter guidance ($1,771-1,789 million).

But this marginal slippage over guidance is not catastrophic - since it is explained largely by a one-time writeoff of $15 million on a European project that got cancelled, and $13 million in foreign exchange losses. Net of these losses, Infosys is actually closer to the upper end of the guidance for the quarter.

Given the unpredictable nature of the US and European markets, the abandonment of the quarterly guidance is not surprising, but the shocker is the sharp drop in rupee earnings by 1.2 percent to Rs 2,289 crore from Rs 2,316 crore between the March and June quarters, when the rupee-dollar rate moved largely in favour of Infosys. Over last year, the year-on-year rupee profit growth has been a nifty 33 percent.

So, has the company really lost out on the dollar-rupee volatility, as the rupee bottomline seems to suggest? Apparently not. The rupee revenue growth has substantially exceeded the guidance of Rs 9,011-9,100 crore for the quarter at Rs 9,616 crore. It is only the net profit that has dropped below expectations, but Infosys has still beaten the guidance. The earnings per share (EPS) figures are higher than guidance of Rs 36.89 at Rs 40.06.

What is worrying is that even with the dollar-rupee rate moving favourably, Infosys’s year-end target is looking like a ordinary multiple of the Q1 results. So “no real growth” is the message even in rupee terms.

CEO and Managing Director SD Shibulal claimed that Infosys’ focus on revamping the organisation, called Infosys 3.0, is working, and “will help us deliver high-quality growth, despite challenges seen in the global economic situation, resulting in slower IT spends by large corporations.”

The stock was down 10 percent as soon as the results were out, which suggests that punters are disappointed with what the company has dished out and the kind of outlook it has painted.

So what is really going wrong with Infosys? Let’s get something from the overall numbers too.

Staff costs, despite the decision to withhold salary hikes, have gone up 24 percent year on year and 10 percent quarter-on-quarter (June over March 2012). This hike is explained by an increase in visa and other costs. Clearly, this is worrisome.

Infosys’ earnings on its cash hoard of Rs 20,596 crore seem to be trending down. They went up 24 percent year on year, but went down 18 percent from Rs 584 crore to Rs 480 crore between March and June this year. More cash is earning less. This needs some explanation. The management has made it clear that it will not abandon its conservative approach to cash - there will be no buybacks. At best, it will offer higher dividends. The cash is being hoarded for future acquisitions, but the management is not going to be stampeded into it by analyst concerns. It will follow its conservative approach to inorganic growth.

Margins may be under pressure, but there does not seem to be any reason to panic. Between the June quarter last year and this year, net margins of Infosys on a consolidated basis have remained around 23-24 percent (net profit as a proportion of gross revenues). While there is obviously some margin compression on some contracts, Infosys is not likely to start undercutting its peers to generate more business in any significant way.

The verticals - financial services, manufacturing, energy (including utilities and telecom), and the retail, logistics, consumer products group - seem to be reporting robust growth in rupee terms in all of them barring energy. Manufacturing and retail seem to have reported the best operating profits growth over last year at 51 percent and 47 percent in Q1, against revenue growth of 39 percent and 34 percent. Financial services and energy profits grew at 34 percent and 12 percent, against revenue growth of 25 percent and 19 percent.

The bottomline is this: Infy is staying the course. It is not changing its strategy of seeking high-margins and conservatism in its acquisitions strategy despite the sea change in the operating environment.

In the short run, it could look like Infosys is underperforming. We will know soon enough, when Tata Consultancy Services (TCS) announces its results later today (12 July).

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