In April 2011, soon after the March quarter results, we had advised investors to reduce exposure to Infosys citing the possibility of range-bound movement due to its limited growth prospects relative to other top-tier IT players.
Since then, the stock has lost over 10% and has rarely crossed the level of 2,900, prevailing at the time of our recommendation, nine months ago. Also, as anticipated, its trailing price-earnings multiple has fallen from over 25 to below 20 in the said period.
Three quarters later, the situation doesn’t seem to have improved significantly enough for us to change our view on the stock. Though the latest December quarter growth in sales and profits was much better compared to the previous quarters, it was largely driven by a steep depreciation in the rupee against the dollar.
The company has reduced its dollar-denominated revenue and earnings per share ( EPS) guidance for the March 2012 quarter from its earlier expectations, which reflects its inability to grow amidst headwinds . This prompts us to have a bearish view on the stock until signs of a rebound in Infy’s business are visible.
Performance and concerns
In the last eight quarters, select Indian IT exporters have reported better-than-expected financial numbers despite turbulent economic scenario in the major markets including the US and Europe. Not only has the business from existing clients grown, but the number of new clients has also increased every quarter.
Infosys as such is no exception to this in that it has added 120 clients in the first nine months of FY12 compared to 105 in the same period last year.It also reported 5% increase in billing rates during the December 2011 quarter from the year ago. The management commentary on the order pipeline is positive with focus on large projects.
However, its performance in the dollar-denominated terms is not impressive. Infy’s operating margin in rupee terms improved sequentially by 300 basis points (bps), while margin on dollar-denominated revenue expanded by just over 80 bps. This shows that the profitability of core operations (excluding the currency movements) has not changed much.
In the nine months to December, the dollar margin in fact dropped by 210 bps to 28.4% from the year ago. ET Intelligence Group’s analysis also highlights that Infy’s sequential revenue growth lagged behind that of TCS and HCL Technologies in seven of the 13 quarters to December 2011 and operating profit growth lagged six times.
This brings to the fore Infy’s struggle to maintain its growth rate in comparison with its peers. Its other peer – Nasdaq-listed Cognizant – may be in a position to replace Infosys as the second-largest IT exporter in a few quarters unless the latter returns to the growth track at the earliest.
Cognizant earned $4.5 billion (approximately 23,176 crore) in the nine months to September 2011 compared to $ 5,223 ( 24,882 crore) for Infosys in the nine months to December 2011. The loss of its dominating position may make it difficult for Infy to attract a premium on billing rates over the competition
Following its lacklustre performance relative to peers, Infosys has been reporting a gradual downward revision in its stock valuation . It has lost the status of IT stock with the highest price-earnings multiple (P/E) to TCS, the country’s largest IT exporter. Infy’s stock trades at a trailing P/E of over 19, much lower than the P/E of around 25 a year ago.
TCS’s stock trades at a P/E of over 23. Infy’ stock is likely to underperform the stocks of peers including TCS and HCL Tech in the coming quarters as well given the limited scope for growth at the moment. Investors may reduce their exposure to the counter.