2023-07-21 09:10:30 ET
Summary
- Infosys has reported mixed results with GAAP EPS of $0.17 missing estimates by $0.01 and revenue of $4.62 bn beating by $10 mn, but has reduced its revenue growth guidance for FY24.
- While the longer term outlook is positive, there are near-term headwinds as client delay projects.
- The company's operating margin was 20.8% in the quarter, an 80 bps YoY improvement, and it has maintained its margin guidance.
- Valuation isn't cheap if we look at the slowing growth.
Infosys ( INFY ) recently reported mixed results, with GAAP EPS of $0.17 missing consensus estimates by $0.01 and revenue of $4.62 bn beating by $10 mn. However, the real bummer was the company’s soft revenue guidance. Management reduced its constant currency revenue growth guidance for FY24 (ending March) to 1-3.5% versus the prior guidance of 4-7% growth. This is the second consecutive quarter where management guidance has significantly disappointed the street. Many analysts were not expecting it, and even management expressed their optimism that they should be able to meet the lower end of the 4-7% guidance range at a Morgan Stanley conference call in June. So, this significant guidance reduction, with revenue growth now expected to be even below the bottom end of the previous guidance range, came in as a rude surprise.
Revenue Analysis and Outlook
I previously covered Infosys in January where I preferred being on the sidelines given worsening macros which I expected to result in a slowdown in revenue growth. These worries proved correct, and management reported some clients stopping or slowing down on transformation programs and discretionary work.
Below is what the company’s CEO Salil Parekh said on the earning call ,
In the short term, we see some clients stopping or slowing down work on transformation programs and discretionary work. This is especially so in financial services, in mortgages, asset management, investment banking and payments, and in the telecom industry. We also see some impact in the high tech industry and in parts of retail.”
So this has created a near-term headwind for the company.
The company’s medium to long-term outlook still remained alright. Its large deal value for Q1 was $2.3 bn out of which 56% were new. The company booked one mega-deal in Q1. The company also announced another mega-deal worth ~$2 billion after the close of the quarter. These deals provide good visibility on the company’s medium to long-term revenues. Further, the company’s deal pipeline remains strong.
The company is seeing good demand in areas like engineering, IOT, supply chain, cloud, ERP, and digital as there is an increasing need for migration to the cloud, increasing productivity by transforming to smart factories and transitioning to smart products. Answering a question on the deal pipeline on its earning call, CEO Salil Parekh commented,
The pipeline, we still have a good pipeline of both large deals. We have some mega deals in the pipeline as well. We see a lot of the work that we're doing on cost, on efficiency, automation in consolidation, those are tracking well with clients. There are some transformation programs, which are funded from within the cost efficiency. Those are also something that we're tracking through. So we do see, with two mega deals signed, a good pipeline today of large deals and we have mega deals in the pipeline as well.”
The company is also well-placed to benefit from the generative AI trend. The company has trained its 40,000 employees on generative AI and Topaz, its AI and generative AI platform, is resonating well with clients. The company's current work on AI includes large language models for software development text, document, voice, and video. Infosys is currently working on 80 generative AI projects. The secular demand in this end-market bodes well for the company in the long term.
So, the company’s revenue outlook is mixed, with near-term headwinds but long-term prospects.
Margin Analysis and Outlook
The company’s margin performance was good, and it posted a 20.8% operating margin in the quarter, which is an 80 bps YoY improvement. However, sequentially the company’s margin was down 20 bps as 70 bps benefit from cost optimization, including utilization, automation, etc. was offset by a 90 bps headwind from employee-related costs.
The company maintained its operating margin guidance of 20-22% for the current fiscal year despite decreasing revenue guidance as it is focusing on cost-cutting. Infosys has launched a comprehensive margin expansion plan which includes working on pyramid efficiency, automation improvement in critical portfolios, reducing indirect costs, etc. and the company has started engaging its client and employees to achieve these goals.
The company is also calibrating its hiring for FY24 based on revised growth expectations, and it's focusing on improving utilization. The company’s utilization excluding trainees improved to 81.1% last quarter, and management sees further room for growth. The IT job market has also seen normalization after a couple of very strong years during the COVID pandemic. So, I believe wage growth should also normalise and be less of a headwind going forward, helping margins. Overall, I am optimistic about the company’s margin prospects.
Valuation and Conclusion
If we look at the company’s valuation, it is trading at 21.94x FY24 consensus EPS estimates of $0.74. If we think about the company’s low to mid-single digit constant currency revenue growth guidance and mid-single-digit EPS growth expectations for the current year, this valuation appears pricey. While the company’s revenue growth rate is likely to improve next year, I believe we are unlikely to see double-digit growth, which we have seen over the last couple of fiscal years.
Prior to the pandemic, the company was growing its revenue in the mid to high-single-digit range, and that seems like a reasonable future growth range in the long run. However, the near term outlook still remains challenging with projects getting delayed. Also, I believe after the recent two quarters of disappointments, an investor may prefer to see growth reaccelerate before buying the stock. Given the mixed revenue outlook and the valuation which isn't essentially cheap, I am not buying this dip and prefer to remain on the sidelines for now.
For further details see:
Infosys: Staying On The Sidelines