Thursday, January 14, 2016

Infosys Q3: Strong show could trigger earnings upgrades

Contrary to the weak show posted by its larger peer -Tata Consultancy Services (TCS), Infosys put up solid numbers for the December 2015 quarter. Notably, Infosys' financial performance has been improving in recent quarters. A key positive in this quarter results is the increasing management confidence on the road ahead as reflected in the upward revision of full year revenue guidance by the company. 

This is significant when viewed in context with the cautious optimistic tone adopted by the management at the end of September 2015 quarter. Management had then cited issues with some clients as a key pressure point. In a post results call with investors on Thursday, though the management indicated that most of the client specific issues are largely sorted out, Infosys now expects its constant currency revenues to grow between 12.8 to 13.2 per cent this fiscal as compared to its earlier guidance of 10-12 per cent. In this backdrop, it is not surprising that the Infosys scrip surged over 6 per cent on Thursday versus a flattish Sensex. 

For the December quarter, Infosys' revenues grew 1.7 per cent sequentially to Rs 15,902 crore aided by a healthy volume growth of 3.1 per cent despite a 1.5 per cent dip in realisations. Growth was fuelled by healthy traction in India business (albeit on a lower base) and Europe (up 3.9 per cent sequentially) even as North America was flat at 0.5 per cent. Most verticals grew at a healthy clip of 3 per cent sequentially to aid overall top-line. Revenues were slightly higher than Bloomberg consensus estimate of Rs 15,758 crore. Net profit was partly aided by a 177 basis points sequential fall in tax rate to 27.2 per cent in the quarter. Consequently, net profit grew 2 per cent sequentially to Rs 3,465 crore and was ahead of Bloomberg consensus estimate of Rs 3,351 crore.  

Infosys' operating margin fell 64 basis points sequentially to 24.9 per cent on the back of weak pricing and utilisations even though a weaker rupee and lower attrition provided some offset. Going forward, management has maintained its near term margin guidance of 24-26 per cent and believes it is on track to ramp up this metric to its aspirational 30 per cent level by 2020.

Interestingly, after posting a weak set of numbers for the quarter, TCS scrip made new 52 week lows repeatedly on Wednesday and Thursday. The stock which was trading at premium valuations vis-a-vis Infosys at the start of this month has now witnessed a reversal in this trend as analysts trimmed their earnings estimates for TCS. So from a premium of about 4 per cent early this month, TCS now trades at a discount of nearly 3 per cent to Infosys on a price/earnings basis. 

At current levels, TCS trades at 16.9 times FY17 estimated earnings while Infosys trades at 17.5 times FY17 price/earnings ratio. Given Infosys' good show, there could be some earnings upgrades for the stock. However, sustained improvement in Infosys' financial performance is a pre-requisite for this valuation premium to sustain or even expand from current levels, believe analysts. 

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