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Exceptional 3Q deal wins to turbocharge FY22

Upward revision to FY21 guidance above expectation; Reiterate Buy

* Infosys (INFO) reported constant currency (CC) USD revenue growth of 5.3% QoQ (v/s our estimate of 3.2%) in 3QFY21. This is its best QoQ growth in the last eight years. Growth was broad-based across verticals and regions. In 9MFY21, revenue (USD)/EBIT/PAT grew by 3.8%/26%/16.4%.

* The company reported its best ever TCV of USD 7.1b (net new wins of 73%), 2x book-to-bill, and above the combined TCV of the last three quarters. While we see a large impact from the Daimler win, other deal wins were much ahead of our estimate.

* We see the exceptional deal TCV as a meaningful driver of INFO’s FY22 topline growth (+18% YoY), even after factoring in the impact from passthrough of revenue in large deals.

*  EBIT margin was flat QoQ, marginally below estimates and below the strong delivery by TCS and WPRO, led by the impact from the Vanguard deal transition (on-site heavy). While we see an impact from Daimler and other deal ramp-ups in FY22, we still expect INFO to expand margin in FY21.

* Even with the revised guidance (4.5-5% YoY CC for FY21), implied growth for 4QFY is only moderate at 0.5-2.3% QoQ CC, which we expect it the company to easily beat. We expect INFO to deliver EBIT margin above the upper end of its FY21 guidance.

* We upgrade our FY21E/FY22E/FY23E EPS estimate by 1%/3%/7% as we adjust our revenue and EBIT margin trajectory to incorporate a strong deal environment. INFO should be a key beneficiary of a recovery in IT spends in FY22, given its capabilities around Cloud and Digital transformation. Leading operational performance in 9MFY21 and strong deal wins should translate into strong outperformance in EPS growth (v/s the sector). Reiterate Buy.

Beat on revenue, marginal miss on margin

* INFO posted a 3QFY21 CC revenue growth of 5.3% QoQ (v/s expectation of 3.2%), its highest sequential growth in the past eight years.

* Revenue in USD terms grew 6.2% QoQ (expectation of 3.7%) and 8.4% YoY.

* EBIT margin remained flat sequentially (impacted by the ramp-up of large deals) to 25.4%, 30bp miss to our estimate of 25.7%. On a YoY basis, margin increased by 350bp.

* Utilization increased by 170bp QoQ to 82.3%, including trainees, and by 270bp QoQ to 86.3%, excluding trainees.

* Adjusted PAT stood at INR 52b, up 16.6% YoY, in line with our estimate.

* Deal wins with TCV of USD7.1b was at a record high. This was led by the mega deal win from Daimler.

* Growth was a function of outperformance in BFSI (+12% YoY CC), Hi-Tech (+17.4% YoY CC), and Life Sciences (+11% YoY CC), but was offset by a decline in Manufacturing (-4.1% YoY CC).

* In CC terms, US grew 8.8% YoY, while Europe/RoW grew 1.3%/6.1%.

* The quarter saw a further shift towards offshore, with the mix increasing to 74.8% as against 73.9% in 2QFY21.

* Digital crossed 50% of total revenue.

* Voluntary attrition for IT Services declined to 10% from 15.8%.

* DSO saw a sequential increase of four days to 73 days. However, FCF/PAT ratio remained healthy at 109%.

* INFO increased its guidance to 4.5-5% YoY CC for FY21 (from 2-3%), with EBIT margin guidance of 24-24.5% (from 23-24%).

Highlights from the management commentary

* INFO reported deal wins of $7.13b, the highest ever in its and the Indian IT industry’s history. Of these, 73% were net new deals. A total of 13 deals was signed in America, while seven were signed in Europe.

* Revenue from these deals is expected to accrue in 2QFY22, with a significant part coming in from net new wins.

* The management is seeing demand come in from cost takeout deals and large enterprises looking to invest in Digital infrastructure. Its capabilities around Digital, Automation and efficiency have become key.

* Margin remained largely flat due to ramp-up of large deals during 3QFY21. The same was impacted by: 1) rebadging cost and transition (-50bps), 2) employee hike (-20bps), and 3) sub-contracting and miscellaneous expenses (-50bps). This was partly offset by improvement in operational efficiencies like utilizations, offshore mix, etc. (+100bps).

* Daimler deal is based on Cloud, with the primary driver being what INFO has built in Infosys Cobalt.

* A lot of the work in the deal is related to Data Centers and infrastructure being migrated to the Cloud.

* The management increased its revenue guidance to 4.5-5% YoY CC (v/s 2-3% earlier) and margin guidance to 24-24.5% (v/s 23-24% earlier).

* No weakness in 4QFY21 is expected by the management. However, some seasonality would keep the momentum low.

* Going forward, growth should accrue from next generation services like Data, Cloud, and Security, while pressure would continue to remain in legacy services. The health of the pipeline is extremely robust

Valuation and view – Multiple divergence v/s TCS should narrow

* Performance during the quarter is indicative of INFO’s technical capabilities and strong sales team presence in the market. Growth over the near term would be driven by USD12b deal wins (net new wins of USD8b).

* For 9MFY21, it delivered strong margin. Some of the margin tailwinds are not sustainable and their benefits would partially wane out as travel comes back, and attrition and offshore ratio normalize.

* We expect INFO to be a key beneficiary of a recovery in IT spends in FY22.

* Our relative preference for INFO over TCS is premised on its headroom for increase growth potential, which was further reinforced by this result.

* As INFO has outperformed TCS in 9MFY21 and is on its way for industry leading performance in FY21 (among Tier I players), we expect the valuation divergence to narrow. Based our revised estimates, the stock is currently trading at 21x FY23E EPS. We value the stock at 24x FY23E EPS, implying a target price of INR1,600.

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