Sustainability of pricing holds the key
* Q1FY18 performance by Infosys Ltd was better-than-expected on reported basis, driven by strong pricing gains of 130bps that led to revenue beating expectations. The management commentary is cautiously optimistic across verticals. The company claims it is winning market share and expects uptick in demand in BFSI in H2FY18.
* Infosys is gaining significantly on its ‘New Services and Software’ that collectively accounts for ~10% of revenues and has clocked US$1bn in revenues in the last 3 years (50% of incremental revenues over FY15-17).
* Focus now shifts to profitability given the declining operating leverage, appreciating INR, wage hike in Q2FY18 and compulsive commitments towards onsite hiring.
* We cut our FY18/19E EPS by 6%/7% to factor in lower profitability in our estimates and downgrade our rating on Infosys to HOLD with a TP of Rs980 based on 14x Mar’19E P/E (implied PEG of 2x over FY17-20E).
Pricing stability crucial to achieve guidance for FY18
Infosys delivered strong performance with a 2.7% qoq growth in constant currency (CC) terms. This was ahead of our expectation of about 1.8% CC growth. At 1.7% qoq, volume growth was in line with expectation but pricing surprised positively with a gain of ~130bps. EBIT margin declined by 50bps qoq to 24.1%, in line with our estimate, but would face headwinds in Q2FY18 on account of wage hikes and planned hiring in US in anticipation of change in demand towards onsite business. Reported PAT declined by 3.3% qoq to Rs34.8bn, in line with our estimate, as the company wrote down its investments in Nova LLC to the tune of ~Rs710mn. Despite the strong performance, Infosys has retained its FY18 revenue growth guidance, which implies 2.5% CQGR over Q2FY18-Q4FY18 to achieve midpoint of its growth guidance. We believe the sustainability of pricing will be the most crucial parameter for the company to achieve its FY18 guidance.
Cut FY18/19E EPS by 6%/7%; downgrade to HOLD with TP of Rs980
We cut our FY18/19E EPS estimates by 6%/7% to Rs64/70, as we incorporate lower INR realisations (accounted for 4% impact on earnings downgrade) and profitability headwinds on wage hikes, onsite hiring and increased investment in training on ‘New Services’ in our estimates. The outlook on the business growth has been largely kept intact in view of in-line volume growth and improved business commentary across leading verticals. Taking into account the earnings cut and current valuations, we downgrade our rating on Infosys to HOLD with a TP of Rs980 based on 14x Mar’19E P/E (implied valuation of over 2x on PEG basis over FY17-20E same as TCS).
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