2023-10-18 10:10:29 ET
Summary
- Infosys reports positive trends in top-line and bottom-line results, reflecting long-term growth potential.
- The company has a strong pipeline of large deals, has major investments in generative AI, and has rewarded long-term investors with generous returns.
- I'm cautious of the reduction in FY 2024 growth guidance and that the stock is trading near its average price target.
Infosys Limited (INFY), one of India's leading IT companies and the world's sixth-largest professional services firm by market capitalization, recently reported positive trends in both its top-line and bottom-line results in its Q2 2024 results. Over the past decade, Infosys has delivered a remarkable 158.05% return to investors, reflecting its long-term growth potential.
Ten-year stock trend (SeekingAlpha.com)
The company holds a promising outlook with a strong pipeline of large deals, a robust financial position, and positive cash flow. However, Infosys generates revenue from large-sized deals. If these deals are delayed, it can impact the consistency and growth performance of the business. We have already seen a reduction in FY 2024 guidance growth reduction due to slow decision-making and a decrease in discretionary spending, which should not be taken lightly. Furthermore, it has a relatively high price-to-earnings (P/E) ratio compared to industry peers, and the stock is trading near its average price target . While there are clearly risks to investing in Infosys, I believe its early investments into generative AI will be one of the major long-term growth drivers, such as a recent five-year contract with a customer worth $2 billion. Therefore, investors may want to take a bullish stance on this stock.
Company Overview
Infosys, founded in 1981 and making a historic entry on Nasdaq in 1999 as the first Indian company, is the second-largest IT firm in India, with a global presence spanning over 50 countries . One of its strengths is that it caters to many companies across a diverse number of industries internationally, providing services such as consultancy, application development, support, infrastructure services, and maintenance. The company generates revenue across seven key segments. The diversity helps the company deliver more consistent revenue growth. We saw that 27.5% of its revenue is from the financial services sector. However, the financial sector is currently negatively impacted by a slowdown in areas like mortgages, asset management, investment banking, cards and payments. This was offset in part by manufacturing's YoY double-digit growth .
While the business is facing challenges across a number of segments that could impact its performance in the near term, we have seen it attain four mega deals in Q2 2024, underscoring its expanding presence in the market. Furthermore one of the major attractions of the company is its early investment into AI capabilities and the training of its staff. Since 2023, Infosys introduced Topaz , its generative AI offering, marking its commitment to cutting-edge AI solutions. In July the company signed a five-year contract with an existing customer that has a target spend of $2 billion . this gives us an indication of the major growth potential.
Investing in Generative AI (Investor presentation 2023)
Near and long-term growth challenges and potential
We are seeing that Infosys is negatively impacted by market uncertainty impacting a number of its key industries, furthermore, the company has experienced delays in some of its deals. If you are looking to invest in the short term, these can be some serious red flags as we have seen the management reduce its FY 2024 for the second time, revising growth projections of 1% to 2.5% in constant currency. Notably, the operating margin guidance for the financial year remains stable, ranging from 20% to 22%. While short-term challenges are on the horizon, Infosys holds a competitive position in a market expected to grow at a CAGR of 6% reaching $1.88 trillion according to Gartner .
Market growth potential (Investor presentation 2023)
Financial Overview
Infosys has demonstrated consistent financial growth over the past decade. In Q2 FY24, the company reported a 2.5% year-on-year increase in constant currency, with operating margins at 21.2%. Notably, Infosys secured large deals worth $7.7 billion, with 48% being new. To enhance operational efficiency, Infosys is implementing a margin expansion program focusing on areas like pyramid, automation, critical portfolio, indirect cost, and value across the organization. Over the past ten years, Infosys's net income has gradually increased, with the TTM figure at $3.01 billion.
Annual revenue trend (SeekingAlpha.com)
Annual net income (SeekingAlpha.com)
In the last quarter, Infosys showcased strong free cash flow at $670 million, reflecting its financial health. The conversion of this cash flow to net profit in Q2 stood at a robust 89%. Notably, the leveraged free cash flow has remained consistently positive and on an upward trajectory over the past decade. Turning to the company's balance sheet, Infosys maintains a liquid and debt-free financial position. Its consolidated cash and investments are substantial, amounting to $4.2 billion , constituting 27% of the total assets. This robust financial foundation underscores the company's stability and liquidity.
Annual levered free cash flow (SeekingAlpha.com)
Valuation
Following its Q2 2024 results, Infosys stock has been on an upward trajectory and is currently trading close to its average price target of $17.82. However, analysts have given mixed reviews due to the reduction of the FY2024 guidance. When we compare Infosys to industry peers like Cognizant (CTSH), Capgemini (CGEMY), Wipro (WIT), and Accenture (ACN), we can see that Infosys has been a rewarding investment over the past five years, yielding returns of 69.30%, with only Accenture surpassing it at 89.42%. While Infosys boasts a forward price-to-earnings ratio (FWD P/E) of 23.59, which is higher than the majority of its peers, suggesting a potential overvaluation at its current stock price, only Accenture surpasses it at 25.64. One of the major attractions to the company has been its ability to consistently win large-sized deals through competitive pricing and its digital business capabilities. While large deals can postpone performance due to the size and delay potential, I believe the company has major upside potential over the long term.
Five year stock trend versus peers (SeekingAlpha.com) Relative peer valuation (SeekingAlpha.com)
Risks
Infosys operates within a highly competitive and ever-evolving industry where its growth relies on customers' willingness to invest across diverse sectors. Economic uncertainties, rising interest rates, and inflation have adversely affected consumer spending, particularly in sectors like financial services and communication. This has led to a slowdown in digital transformation initiatives and reduced expenditure on discretionary projects. Any reduction in digital transformation efforts and discretionary spending may pose challenges to Infosys's growth prospects. Moreover, Infosys has achieved substantial growth by securing large deals through competitive pricing. However, this approach carries risks, especially if costs escalate, eroding profit margins. Furthermore, large deals can introduce a higher probability of delays, potentially impacting the company's short-term performance and financial health.
Final Thoughts
Infosys has had a remarkable growth journey by increasing its revenue and profits through a strategy of winning large-sized business deals and investing in digital business capabilities. This strategy has helped the company attract long-term revenue. However, there are some near-term challenges due to the delays experienced in these deals, such as slow decision-making and a decline in discretionary spending in many sectors, which is being impacted by an uncertain economy. Although we need to be cautious of these headwinds, the company has a strong track record of winning deals and is already seeing significant victories due to its AI capabilities. Therefore, I believe investors may want to take a long-term bullish stance on this stock.
For further details see:
Infosys: Weathering Short-Term Challenges For Long-Term Growth Prospects