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* Investment intensity to peak in Q1FY20
We met Mr. Jayesh Sanghrajka, Executive Vice President and Deputy CFO, Infosys. Demand trends are constructive barring mid-market banks, manufacturing in Europe and Lifesciences and Healthcare (globally). Most of the planned investments will be complete by Q1FY20 with operating leverage to manifest from Q2FY20. Infosys has applied for more visas in FY20 than in prior few years which should help stem attrition (more onsite opportunities for associates) amongst other interventions. We maintain ADD rating with a revised target price of Rs800 (from prior Rs755) based on 19x FY21E EPS (prior 18x FY21).
* Investment intensity to peak in Q1FY20; margins to improve there-after.
Infosys had ramped up investments in FY19 around the following key themes: 1) Localisation 2) go-to-market 3) capacity creation 4) reskilling, and, 5) strategic relations/large deals. Infosys believes that the heavy lifting on these investments is now behind (post some incremental investments in localisation in Q1FY20) with focus to be on improving margins here-on. Higher digital mix, productivity and employee pyramid (if revenue growth sustains atleast in high single digits) are expected to be the key margin levers over the medium term with comfort on utilisation (ex-trainees) being in the range of 83-84% (vs 82.3% in Q4FY19 and a peak of 85.7% in Q1FY19).
* Status quo on demand since Q4FY19-end; typical strong H1 seasonality to manifest in FY20.
Demand trends are generally constructive barring in regional/midmarket banks, manufacturing in Europe (autos and industrial) and Lifesciences and healthcare (globally). Growth in the BFSI vertical is expected to be in-line with the company average in FY20 including contribution from Stater (strategic partnership with ABN AMRO). Retail, communication and hi-tech verticals should lead growth for the company in FY20 in our opinion. Spends from the E&U vertical have historically had high sensitivity to oil prices and bear a close watch given the recent sharp correction in crude prices.
* Maintain ADD.
We now expect EBIT margin in Q1FY20 to decline by a steeper 125bps QoQ to 20.2% given drags from 1) wage hikes to be given to 85% of employees, 2) visa costs, which are expected to be higher than in prior years, 3) INR appreciation, and 4) probable normalisation of bad-debt provisions. However, we expect margins to improve there-on and be 21.2% in FY20 and 22% in FY21. We expect revenue growth to be 9% in USD terms in FY20 with stronger H1 seasonality with the Stater JV to be integrated for nearly one month in Q1FY20 (transaction closed on May 24th). With investments bearing a healthy return as demonstrated by 3.3x increase in net-new deal TCV in FY19 and digital strategy finding resonance (digital +32% YoY in FY19; being 33.8% of revenues in Q4FY19) we maintain ADD.
* High performer attrition more contained than the headline number; higher visa applications in FY20 to help lower attrition.
After being down from 20.6% in Q1FY19 to 17.8% in Q3FY19, Quarterly annualized (QA) attrition (standalone) increased again in Q4FY19 by 50bps QoQ to 18.3%. However, high performer and client facing delivery attrition (including project managers) is reasonably lower as per the company. Attrition is higher in the 2-4 year experience bucket where connect with the organisation is typically lower and still evolving and higher competing offers matter more. Applications for H1-B visas, which had reduced considerably in the past few years given accelerated localisation efforts, have gone up in FY20, availability of which should create more onsite opportunities for employees in lower experience brackets. Infosys has also implemented multiple other initiatives to rein-in attrition including 1) prioritized deployment of high performers on digital engagements, and 2) milestone, rather than experience based retention bonuses.
* Large deals to help sustain growth in FY21.
Barring “lift and shift” deals like with Verizon, large deals typically ramp-up gradually over time with revenue conversion in first year typically being 8-10% of TCV. Some of the large deals won in FY19 (including Verizon) have also been strategic in nature, where the company is making upfront investments at the expense of margins but ensuring better likelihood of gaining higher wallet share of downstream spends from these clients. Both of these factors should help sustain revenue growth in FY21 and underpin our 8.5% revenue growth estimate for that year.
* Valuation methodology and key risks
We maintain our ADD rating on Infosys with a revised target price of Rs800/share (from earlier Rs755/share) based on 19x FY21E EPS (prior 18x). The key risks to our call are: i) weaker than expected execution in margins, ii) weaker than expected TCV of deal wins, iii) weakness in discretionary spends, and iv) INR appreciation.
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