Expect a further upward revision in its guidance
Long-term traction intact, reiterate Buy
* INFO reported strong broad based growth of 4.8% QoQ CC, beating our estimate of 3.9%. Deal TCV stood at USD2.6b, implying a growth of 48% YoY. While net new deal wins were relatively lower at 30%, the deal pipeline remains strong given the robust demand environment.
* EBIT margin fell 80bp QoQ to 23.7% in 1QFY22 (est. 24.8%), due to a 50bp/80bp impact from higher subcontracting expenses (highest in the last five years)/employee cost (on retention/hiring and promotions). This was partially offset by a 40bp/10bp impact from utilization/currency. Utilizations and offshore mix remain stretched, indicating a strong demand environment.
* The management increased its FY22 USD revenue growth guidance to 14- 16% CC YoY from 12-14%. It characterized the current demand environment to be one of the strongest in a while.
* We expect INFO to deliver another year of an ongoing guidance raise as the current one does not fully factor in strong technology demand and execution of its record high deal wins (LTM deal wins rose 86% YoY to USD14.9b).
* A strong topline growth (est. +18% YoY) should allow INFO to keep EBIT margin intact (due to a wage hike in 2QFY22, large deal ramp up, stretched operating metrics, and increased subcontracting expenses) at the upper end of its guidance. Apart from operating leverage, it should also benefit from the further flattening of the pyramid (expected additions of 35K freshers in FY22) and increased efficiency measures.
* We see the sharp (300bp QoQ) rebound in attrition (to 13.9% in 1QFY22) as concerning, especially as utilization was at record high of 88.5%, which is unsustainable. This remains a key monitorable in our view.
* INFO reported a strong FCF/PAT conversion of 122% in 1QFY22. FCF rose 19% YoY, led by a robust increase in operating income and lower capex.
* We have cut our FY22E/FY23E EPS estimate by 3.2%/1.6% to encompass margin pressure due to ongoing supply crunch in the industry and expected increase in travel expenses. We continue to view INFO as a key beneficiary of a recovery in IT spends in FY22, given its capabilities around Cloud and Digital transformation. We value INFO at 27x FY23E EPS and reiterate our Buy rating.
Strong growth performance; miss on margin due to supply pressures
*Revenue (CC)/EBIT/PAT grew 16.9%/22.7%/22.3% YoY in 1QFY22.
* Revenue growth of 4.8% QoQ CC in 1QFY22 beat our expectation of 3.9%. In USD terms, revenue grew 4.7% QoQ (est. 3.9%) and 21.2% YoY in 1QFY22.
* Growth was a function of outperformance in BFSI/Retail/Life Sciences (+22.6%/+22.2%/+22.1% YoY CC). Growth in the Communications segment remained muted at 4.6% YoY CC.
* US/Europe/RoW grew by 21.1%/12.2%/4.9% YoY CC.
* Digital grew by 42% YoY, and were at 53.9% of total revenue.
* Large deal TCV in 1QFY22 stood at USD2.6b.
* EBIT margin dipped 80bp sequentially (despite an increase in utilization and offshore mix) to 23.7%, 110bp miss to our estimate of 24.8%. On a YoY basis, margin increased by 100bp.
* The dip in margin was majorly led by a 50bp/80bp increase in subcontracting expenses/employee cost (on retention/hiring and promotions). This was partially offset by a 40bp/10bp impact from utilization/currency.
* PAT grew 22.3% YoY to INR51.9b, 5% below out estimates.
* Attrition inched up by 300bp QoQ, while utilization, including trainees, was further stretched to 83.3%, an increase of 110bp.
* DSO (LTM) reduced by a day sequentially to 70 days. FCF grew 18.5% YoY to USD863m. FCF conversion stood at 122.3% of net profit.
* INFO raised its FY22 guidance by 200bp to 14-16% YoY CC. Its EBIT margin guidance remained unchanged at 22-24%.
Highlights from the management commentary
* The company witnessed broad based growth across all sectors, service lines, and geographies, with the Digital business growing by 42% YoY. There has been sustained growth acceleration, with seven industries reporting strong doubledigit growth. With Cloud becoming a Digital priority, many clients are taking advantage of Infosys Cobalt.
* Growth was led by the US, especially in the Banking and Retail segments, as clients start making aggressive investments to improve its Digital capabilities. A lot of the discretionary spending is also returning.
* Within Europe, there had been a lesser demand from its Banking clients and ramp up of few deals were delayed, impacting performance. However, this is not a secular trend and the issue is more customer specific.
* This, along with a return of travel and other discretionary cost, should pose as margin headwinds. However, pyramid rationalization and further automation should help offset these headwinds. The management is confident of achieving its margin guidance band of 22-24%.
Valuation and view – Expect multiples to converge with TCS
* INFO posted a strong growth in 1QFY22. We expect the company to deliver a top quartile growth performance in FY22E on the back of its strong technical capabilities and ramp up in deal wins in FY21.
* It delivered a strong margin in FY21. Some margin tailwinds are not sustainable and their benefits would partially wane out as travel returns, and attrition and offshore ratio normalize.
* We expect INFO to be a key beneficiary of a recovery in IT spends in FY22E.
* Our relative preference for INFO over TCS is premised on its headroom for increased growth potential, which was further reinforced by this result.
* As INFO has outperformed TCS in FY21 and in 1QFY22, we expect no valuation divergence between the two companies. Based on our revised estimates, the stock is currently trading at 24x FY23E EPS. We value the stock at 27x FY23E EPS, implying a TP of INR1,770.
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