2023-03-23 05:56:57 ET
Summary
- Infosys, the second largest Indian company by market capitalization, is an IT consulting company that assists companies from different fields in their path towards digital transformation.
- Its flexible and widely diversified business model permitted the company to thrive also during economic downturns and we can expect Infosys to keep succeeding in the future.
- If we combine the prowess of its business model with the copious shares buyback done over the years, Infosys represents a good investment opportunity at today's prices.
Investment Thesis
Infosys ( INFY ), the second largest Indian company by market capitalization, is an IT consulting company that assists companies from different fields in their path towards digital transformation.
Other than helping other companies succeed, Infosys has been a successful company itself registering steady growth in revenues and strong cash flow generation in the past years thanks to its high efficiency and profitability.
Its flexible and widely diversified business model permitted the company to thrive also during economic downturns like the 2020 covid pandemic and in 2022 when macroeconomic issues like high inflation arose. Given its past prowess and such a resilient business model, we can expect Infosys to keep succeeding in the future.
In today’s analysis, we will assess why Infosys represents a good investment opportunity at today’s prices given its intrinsic value of $21.6.
Business Model
Infosys provides its consulting services to basically every industry in existence with a particular focus on the financial (32%) and retail sectors (14.6%). The vast number of services offered can be summarized by saying that Infosys helps companies to implement sophisticated software into their operations aimed to help them improve efficiency, profitability, and customer and employee relationships.
Over the years Infosys has developed key partnerships with professional software companies like Microsoft, AWS and Salesforce becoming one of their main partners and enabling companies to adopt their solutions in the smoother and most effective way possible.
To offer its services Infosys relies on its skilled and well-trained workforce, accounting for more than 300 thousand employees of which 78% are in India.
Revenues are generated by consulting service fees and despite being an Indian company, 62% of total revenues are generated in the US followed by Europe at 25%.
Operating Performance
Looking at Infosys’s past performance, revenues grew at a compound annual growth rate ((CAGR)) of 8.93% since 2013 and are expected to be around $17.4 billion in the 2023 fiscal year.
Infosys achieved great efficiency and profitability over the years with a 5-year median operating margin of 23% and a median return on invested capital ((ROIC)) of 30.4%.
Steady growth in revenues and high margins turned into solid free cash flows to the firm (FFCF) which grew at a CAGR of 13% from $826 million in 2013 to $2.8 billion expected in the 2023 fiscal year.
Financially, Infosys is very solid with a net cash position of $1.5 billion and an interest coverage ratio of 113, meaning that the EBIT after tax can cover the interest expenses 113times.
Growth Drivers
As said before, in order to offer its services Infosys needs to invest in its employees’ training to assure that they will be able to offer the best consultancies to its clients. It’s clear that employees’ training costs represent one of Infosys’ major growth drivers as they represent an investment that will pay off in the future.
Infosys currently employs 297 thousand of professional figures, excluding the marketing and administrative staff. Infosys’ utilization rate, representing the percentage of time actually spent in productive activities for the company by Infosys’s employees, was 82% in the fiscal year 2022 while the utilization rate excluding the time spent by its employees to follow training courses was 88%. We obtain that for 6% of their working hours, Infosys’ employees follow training courses.
Knowing the amount Infosys pays for its professional figures, we can assume that 6% of these costs are related to training costs. Of course, this method might seem over simplistic but for the sake of simplicity can be used to try to assume how much a consulting company invest in its main growth driver, alias employee training.
Infosys training costs (Personal Data)
Future growth can be determined by looking at how much and how well a company has invested in its growth drivers. The Reinvestment Margin shows what percentage of revenues has been reinvested into the company, while the Sales to Invested Capital ratio, shows how much revenues have been generated for each dollar invested by the company. If we multiply these two values and take the median value over the years, we obtain the expected growth rate in revenues based on how much and how well a company has invested in its growth drivers.
In our case, Infosys’ expected growth rate is 10.68%.
Market & Risks
The IT consulting market is expected to grow at a CAGR of 6% from 2023 to 2027, principally driven by the increasing adoption of digital technologies among companies from every industry to leverage on their data and improve their competitiveness.
Other than the competition risk pending on Infosys from bigger companies like Accenture (ACC) and Tata Consultancy Services ((TCS)) which might steal Infosys clients and market share, a major risk that should concern investors refers to the company client portfolio and the weight that each industry has on Infosys’ total operating profits.
Despite the Financial sector accounting for the majority of revenues, when it comes to operating profit the Retail sector contributes the most (34.6%). Being the Retail sector a highly cyclical one Infosys’ bottom line might be badly affected by a slowdown in consulting expenses undertaken by retail companies to save costs. However, as said in the introduction, Infosys performed relatively well during the past two economic downturns.
DCF Model
I use the discounted cash flow ("DCF") analysis method to value companies. The aim of a DCF analysis is to determine the present value of expected cash flows generated by the company in the future. The first step is to project the growth rate at which revenues will grow in the future. Secondly, we will need to assume the degree of efficiency and profitability at which the company will turn revenues into cash flows.
Efficiency is represented by the operating margin, and profitability by the ROIC. Having the revenue projections and future operating margins, we obtain the EBIT and, after subtracting taxes, we get the net operating profit after taxes. The ROIC is used to determine the reinvestments needed to support future growth, determining how much profit the company generates from every dollar reinvested into the company.
Future cash flows are calculated by subtracting the reinvestments from the net operating profit after taxes. The higher the growth rate, the higher the reinvestments needed to support it, hence the lower future cash flows will be.
The last step of a DCF analysis is to apply the discount rate to future cash flows, usually calculated using the weighted average cost of capital ('WACC').
Projections
Trying to project Infosys’ future performance we will assume the company to keep delivering solid and consistent results.
Starting with revenues, we can apply the expected growth rate of 10.68%, based on how much and how well the company has reinvested in its growth drivers, and let it slowly decline as the company reach the steady state. Revenues are expected to almost double in ten years reaching $32.8 billion at a CAGR of 6.56%.
Moving on to future efficiency and profitability, here we can simply assume the company will maintain its median operating margin and ROIC of 24% and 30% respectively, as it has already proved to maintain consistent efficiency and profitability over the years.
With these assumptions, FCFF are expected to double by 2033 reaching $5 billion at a CAGR of 6.23%.
Valuation
Applying a discount rate of 7.61%, calculated using the WACC, the present value of these cash flows is equal to an equity value of $89.7 billion or $21.6 per share.
Conclusion
Given my analysis and assumptions, Infosys’ stocks result to be undervalued at today’s prices.
Infosys' success has its root in its flexible and well-diversified business model that permits the company to deliver positive results even in bad periods. If we combine the prowess of its business model with the fact that Infosys’ management has been buying back a copious amount of shares over the years, increasing shareholders' ownership, Infosys represents a good investment opportunity at today’s prices.
For further details see:
Infosys: Delivering Value While Helping Other Companies Succeed