2023-07-04 21:16:58 ET
Summary
- The IT consulting industry is expected to achieve strong growth as AI and other digital capabilities further present value to corporates.
- We highlight AI, Cloud migration and related services, and cyber security as key areas of growth, in addition to its core development services.
- Infosys is forecast to grow at a CAGR of 10% and maintain its industry-leading margins, which will support strong distributions to shareholders.
- Infosys is attractively valued relative to its historical trading range.
Investment thesis
Our current investment thesis is:
- Infosys is positioned perfectly to exploit the improving demand for IT consulting services, boasting impressive profitability and deep expertise.
- The company has grown incredibly well and is expected to continue this.
- When compared to other IT firms, Infosys performs incredibly well, with better growth and margins.
Company description
Infosys Limited ( INFY ) is a global company that provides consulting, technology, and digital services worldwide. They offer a wide range of solutions, including application management, infrastructure services, outsourcing, and product engineering. Infosys serves various industries such as finance, manufacturing, retail, and healthcare.
Share price
Infosys' share price has performed relatively well in the last decade, slightly outperforming the market. This has been driven by a sustained improvement in the company's financials, as well as the development of industry tailwinds.
Financial analysis
Presented above is Infosys' financial performance for the last decade.
Revenue & Commercial Factors
Infosys' revenue has grown at a CAGR of 9%, an impressive level during a period of economic expansion and increased demand for consulting services. Infosys had no single period below 6% growth, illustrating the consistency of its gains.
Business Model and Competitive Positioning
Infosys operates as a global technology services and consulting company, offering a range of services within this specialism. Infosys' objective is to support the digitalization of a company's operations. This consulting segment has performed incredibly well in the last decade, as technological development has created avenues for significant operational improvement, contributing to corporate demand to transform their back office operations. The best example of this is migration to the cloud, allowing businesses to improve efficiency, cut costs, and improve data management. Our expectation is for this tailwind to continue in the coming years, as further improvements are discovered (through AI for example), as well as new businesses requiring support once reaching a sufficient threshold.
As a consulting business, its primary value driver is its people. The company currently has over 300,000 employees and is continuing to rapidly expand the number of heads. This should contribute to growing revenue in the coming years, so long as the company is able to proportionately win additional work. When considering employee utilization, we note the current level is 80% (Excl. training). This implies Infosys is running close to its healthy maximum and so has scope for further growth.
One of Infosys' key selling points is that the company has the capacity to deliver end-to-end solutions to clients, leveraging both technologies such as data analytics and cloud computing, as well as its deep expertise and proprietary processes. This is becoming an increasingly important requirement of corporates, as the complexity of services means it is easier to have a single integrated provider.
The primary form of differentiation in the consulting industry is brand. It is incredibly difficult to accurately judge the difference in quality between businesses, with reputation and creds (prior projects completed) far easier to assess. According to Vault, Infosys is ranked 9th for IT Strategy Consulting , higher than its Indian peer Tata Consulting. Further, the company boasts a large array of leading businesses across various industries as clients.
Consulting Industry
Having touched on it previously, the rapid advancements in technologies such as AI, IoT, and blockchain services (among many others) are driving digital transformation across industries. It is critical for Infosys to develop its expertise in this area and to discover avenues for value, as this represents an opportunity to both gain and lose market share. Infosys recently launched Infosys Topaz , which is an AI-first set of services, solutions, and platforms using generative AI technologies. Infosys has provided the following example of its use case: "A food and beverages chain leveraged Infosys Topaz to autonomously connect unconnected data signals coming in from new partners to deliver superior off-store consumer experience with >95% accuracy."
The shift towards cloud computing and the increasing demand for hybrid and multi-cloud solutions are reshaping IT infrastructure. Costs continue to decline, contributing to increased demand for the service, as the value proposition widens. We believe this is another key growth area that will continue to propel Infosys forward.
Finally, the rising number of cyber threats and data breaches (due to technological development and the incorporation of tech into companies' operations) are driving the need for robust cybersecurity solutions and data protection measures. The average breach cost is currently estimated at $4.35m , representing a large present cost to businesses that need mitigating. We see this as another growth trend for Infosys to exploit.
Due to the increased complexity of services provided, we have seen consolidation in the market, as large firms acquire specialist boutiques. We believe this is an opportunity for Infosys as the businesses it has acquired thus far have generally been successful.
Overarchingly, the world is becoming increasingly complicated as technology finds itself in every facet of society. This is not a natural competency of every business and so the consulting world is more important than ever to guide businesses to maximize their performance.
Margins
Infosys has attractive margins, with a GPM of 30%, EBITDA-M of 23%, and a NIM of 16%. Over the historical period, Infosys has experienced a degree of margin erosion, much of which has occurred in the last 2 years.
This decline in margins is a reflection of current inflationary pressures, as Infosys has experienced an increase in the cost incurred to deliver its services. This is likely in part to slow attrition, which had increased to over 25% in certain quarters during 2022, and has now fallen to 21%.
Our expectation is that some initial margin improvement will be felt in the coming 12 months. This will occur as wage inflation slows and the uplifting of rate cards (the amount charged to clients) begins impacting revenue. This said, we may not necessarily see the levels reached in FY21, as this would involve hiking prices substantially to clients, which is uncompetitive.
Balance sheet & Cash Flows
Infosys' cash flow generation has been incredibly consistent, which is reflective of the business model. This has funded large consistent distributions, primarily in the form of dividends.
Infosys has achieved its current growth without the utilization of debt, providing the business with the flexibility to conduct M&A in the future to support organic growth.
Outlook
Presented above is Wall Street's consensus view on the coming 5 years.
Analysts are forecasting continued strong growth, with a CAGR of 10% expected into FY27. This is a reasonable estimate in our view given the industry tailwinds that will continue to push the business forward.
Margins are expected to slightly improve in the coming years, likely for the same reason we discussed above.
Industry analysis
Presented above is a comparison of Infosys' growth and profitability to the average of its industry, as defined by Seeking Alpha ( 24 companies).
Infosys performs extremely well relative to its peer group. Growth is marginally better but the superiority is in the profitability metrics. Currently, only 1 business has a better EBITDA-M (by 0.9%), illustrating how attractive Infosys is on this metric.
Profitability growth slightly underperforms but this is biased by growing businesses achieving noticeable improvements.
Based on this, we believe Infosys is highly attractive on a relative basis.
Valuation
Infosys is currently trading at 15x LTM EBITDA and 13.5x NTM EBITDA. This is a marginal premium to its historical average.
Our view is that this implies value at the current share price, namely for the following factors:
- Improved industry tailwinds contributing to greater growth expectations.
- Increased scale achieved relative to historical levels.
- Improved distributions.
- Near-term margin improvement.
- Attractive relative position in the market.
Key risks with our thesis
The risks to our current thesis are:
- Margin deterioration as Infosys is exposed to increased risk of wage inflation as economic development continues.
- As a global business converting to Indian Rupees, Infosys faces heightened FX risk.
Final thoughts
Infosys is a highly attractive business. The industry is growing well and is supported by long-term tailwinds, as the digital revolution continues. Infosys is positioned well to exploit this, as it has high margins, deep expertise, and a global workforce.
Infosys looks attractively priced, as it is trading at a small premium to its historical average.
For further details see:
Infosys: A Top Pick During The Digital Revolution