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Headwinds largely priced in, most attractive risk- reward in IT space

Infosys’ (INFY) Q1FY24 result is likely to be weak and that is largely known to the street. We believe INFY’s FY24 revenue guidance of 4-7% YoY CC is healthy because CQGR of 2.3-2.9% implied by mid to high end of the guidance is higher than INFY’s pre-covid CQGR of 2.2%. It is also higher than the CQGR implied by the guidance of larger peers like Accenture (ACN), Capgemini (CAP) and TCS (refer Table 1). Barring the guidance miss in Q4FY23, Infosys has a good track record of upgrading or retaining the guidance over the course of the year and delivering near higher end of the guidance during Salil Parekh’s tenure. We believe this credible performance is likely to continue.

INFY has strong digital capabilities around SaaS and hyperscalars (refer Table 5) and is best placed to benefit from the revival in demand for digital technologies over FY25-26E. Demand is healthy for most SaaS players as they have either retained or slightly upgraded their CY23/FY24 guidance during Q4FY23 results (refer Table 6). Additionally, CQGR implied by the guidance of these SaaS players points towards pick-up in growth in H2FY24/H2CY23. Similarly, consensus expects hyperscalar revenue growth to revive in CY24 and CY25 post dip in CY23 (refer Table 7). This is positive for IT services companies like Infosys, which derives ~62% of its revenue from digital services.

We believe INFY’s margins will likely remain subdued over the next three years (FY24- 26) given: 1) company’s focus on winning large/mega deals that are typically margin dilutive in initial years, 2) benefit of pyramid optimisation is largely behind (refer Tables 8-9), 3) little scope to improve offshore effort mix which is near optimum levels, 4) travel costs as %age of revenue to increase gradually vs FY23, though may not go back to pre- covid levels. Above-margin headwinds can be partially offset by improvement in utilisation (300-400bps below optimum levels currently) and reduction in sub-con costs (200-300bps above pre-covid levels currently). We assume 90bps decline in margins over FY23-26E for INFY.

INFY is trading at an attractive valuation of 19.6x 1-year forward P/E closer to its last 15- yr average multiple of 19x. We believe soft revenue growth in FY24 is already factored in the current stock price, and announcement of mega deal wins will potentially help the stock re-rate from these levels. INFY has already announced 4-5 deal wins in the current quarter (Q1FY24) and has good mega deal pipeline with some deals in advanced stages. We believe risk-reward ratio is favourable with limited downside (~8-9%) for INFY from current levels in a bear case scenario of ~8-9% YoY CC revenue growth in FY25E and FY26E (refer Table- 10). We continue to value INFY at 23x on FY26 EPS of Rs80, discounting back by 1 year at 12% to arrive at a target price of Rs1,641 (unchanged), implying ~30% potential upside; maintain BUY rating on the stock.

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