Equity Research Report: INFY

Infy is a major beneficiary of global inflation as companies are now embarking on cost optimization by adopting greater automation, digital and cloud adaption

Infosys (INFY) is an Indian MNC and IT services company (mainly an exporter). Infy is a global leader in next-generation digital services and business consulting firms. Infy’s end-to-end business solutions include consulting, systems integration, enterprise solutions, and advanced technologies (AI, cloud computing, enterprise mobility). Infy’s business IT services comprise application development and maintenance, independent validation services, infrastructure management, engineering services comprising product engineering and life cycle solutions, and business process management. Infy helped global enterprises to navigate their digital transformation powered by cloud technology (backed by AI-powered core).

Infy’s products, business platforms, and solutions accelerate intellectual property-led innovation, including Finacle (banking product/software), which offers solutions to address the core banking, mobile banking, and e-banking needs of retail, corporate and universal banks worldwide. Infy has a presence/office in more than 50 countries with over 300K workforces, having 40 years of experience in managing the system and workings of global enterprises. Infy also provides outsourcing services and it’s the 2^nd largest Indian IT outsourcing/service company after TCS.

Over 85% of INFY’s revenue comes from North America/U.S. and Europe and BFSI (banking & financial service) is Infy’s bread & butter. Generally, around 68% of Infy revenue is in USD ($), while 32% is in other currencies.

Key management:

Board Members:

Key Shareholders:

Summary of latest report card: Q2FY23 (Consolidated: INR 100 Cr. =1B)

·         Operating revenue Rs.365.38B vs 344.79B sequentially (+6.00%) and 217.710B yearly (+23.43%)

·         Operating expenses Rs.276.36B vs 266.06B sequentially (+3.87%) and 64.697B yearly (+26.94%)

·         EBITDA Rs.89.02B vs 78.64B sequentially (+13.20%) and 78.31B yearly (+13.68%)

·         Interest expenses Rs.0.66B vs 0.56B sequentially (+17.86%) and 0.48B yearly (+37.50%)

·         Core operating profit (EBTDA=EBITDA-INTT) Rs.88.36B vs 78.08B sequentially (+13.17%) and –Rs.77.83B yearly (13.53%)

·         Core operating EPS (EBTDA/Share) 21.05 vs 18.61 sequentially (+13.11%) and 18.56 yearly (+13.42%)

·         Core operating (EBTDA) margin 24.18% vs 22.65% (+1.53%) sequentially and 26.29% yearly (-2.11%)

·         EBITDA margin 24.36% vs +22.81% sequentially (+1.55%) and +26.45% yearly (-2.09%)

Overall, Infy reported a blockbuster and also above-market estimate report card for Q2FY23 despite the concern of synchronized economic slowdown/recession on both sides of the Atlantic (U.S.-Europe) and lower tech/digital spending by corporates/enterprises.

Infy report card as per company announcement:

Highlights of management comments (presser and Q&A): Q2FY23 report card

·         Q2FY23 revenue growth +18.8% yearly (y/y) and +4.0% sequentially (q/q) in CC (Constant Currency)

·         Overall Q2 revenue growth was broad-based in all industries (segments) and geographies in healthy double-digits in CC (North America 15.6%; Europe 28.5%; Manufacturing 45%; EURS 24.3%; Communication 18.4%; retail 15.4%)

·         H1FY23 revenue growth was +20.1% in CC (y/y) led by a strong pipeline of large deals

·         Digital revenue comprised around 61.8% of overall revenue and grew +31.2% (y/y) in CC

·         Operating margin +21.5% in $ terms, grew sequentially by +150 bps amid cost efficiencies, optimization of large deals, and currency benefit (strong USD against INR, GBP, and other currencies) despite some salary increase and cross currency headwinds

·         H1FY23 operating margin was +20.7%

·         Overall demand environment was healthy amid broad-based growth and a robust large deal pipeline despite the cautious behavior of clients amid macro headwinds

·         Large deal TCV was robust at $2.7B, the highest in the last 7-QTRS;

·         54% of large deals are net news led by automation/digital transformation focusing on cost optimization (reduction) of clients amid increasing macro headwinds (inflation)

·         Infy is focusing cost optimization agenda of clients through its automation/digital tech

·         FY23 revenue guidance revised to 15-16% vs the previous 14-16% in Q1 and 13-15% in Q4FY22 (CC)

·         Revenue guidance tailwinds-probabilities of large deals, while global economic slowdown (like mortgages, retail, telecom, and high tech spending) are some of the headwinds

·         The management is cautiously optimistic as discretionary company spending may be affected

·         FY23 operating margin guidance was also revised to the lower end of 21-22% from 21-23% in Q1 ($)

·         Infy’s unique digital and cloud solutions help clients to navigate their business transformation, which resulted in large deal wins and steady all-round growth for the company

·         The demand pipeline is resilient despite the fragile global economic outlook as clients remain confident in INFY’s ability to provide the digital/cloud tech solutions they need for incremental growth and efficiency of their business along with cost optimization

·         Operating margin improved sequentially due to operational rigor, despite supply side challenges (attrition) and elevated operating cost structure (after COVID, traveling cost increased)

·         Interim dividend Rs.16.50/share

·         Buyback of shares for a maximum of Rs.93.00B (against around Rs.94B cash reserve) at a maximum price of Rs.1850/share

·         A share buyback is limited to 15% of share capital as it’s an open offer

·         Cloud revenue higher than $1B led by industry-leading Cobalt capability

·         Attrition levels on a declining trend

·         Infy is confident about revenue guidance amid large deals pipelines, where companies are more interested in automation and cost efficiencies

·         Digital revenue is poised to grow by over +30% in Europe and +15% in the U.S.

·         Infy is confident about margin expansion in H2FY23 due to proper utilization of the reserve bench and lower attrition (salary cost pressure)

·         Infy is quite confident about Europe amid large deals pipeline, but also is cautiously optimistic amid macro headwinds and the Russia-Ukraine war

·         Infy is properly utilizing freshers by providing them with the necessary training, and skills, putting them into projects, and eventually in large projects-all these are helping margins (lower salary cost); has around 40K freshers in all segments right now; added around 10K in Q2 after 21K in Q1

·         Despite macro headwinds, European clients are more interested in growth/transformation programs along with cost efficiencies, where Infy is supporting them with automation, digital and cloud services  

·         The buyback and dividend policy is in line with Infy’s 5Y strategy of providing higher shareholder return of around 85% of FCF; buyback is also EPS accretive

·         H2 is traditionally weak half because of holidays and furloughs

·         Infy allows limited gig work (moonlighting) for the last several years for selected employees within the company platform ‘Accelerate’ and even an external environment with prior approval of the company but does not support dual employment

·         Infy is quite confident about its digital, cloud, automation, AI, and Machine Learning (ML) technology, which clients seek for greater efficiencies

·         Infy management is engaging with employees continuously for motivation and lower attrition

·         Large companies are now seeking cost efficiencies  despite various macro headwinds which affected discretionary spending

·         Infy is hiring freshers as per the overall original plan without any concern about the demand side

·         Infy is adopting a flexible WFH/WFO hybrid policy except where it’s mandatory to work from the office as per client requirements; overall the policy is supporting lower attrition

·         Had 27 large deals each over $50M (18 in North America; 6 in Europe; 1 in India and 2 in the rest of the world)

·         Segment wise Large deals: BFSI-5; retail/communication/energy/Hi-Tech-4 each; manufacturing-3; life science-2; others-1

·         BFSI growth is being supported by account expansion, new account openings, and increasing adoption of the cloud platform

·         Retail segment growth was supported by an increasing focus on digital consumer engagements (online sales), supply chain transformation, cost optimization, legacy modernization, and new in-store capabilities despite some slowdown in fashion/apparel retail and general merchandisers amid macro/inflation headwinds

·         Infy sees increasing cost pressure from the traditional communication segment amid macro headwinds in the coming days despite a healthy order pipeline and deal conversions

·         The energy, Utility, resources, and services segment reported robust and steady growth amid the need for cost optimization

·         The manufacturing segment remains robust amid continued tech spending by clients for higher security, migration to the cloud, higher productivity by automation, and other broader digital transformation initiatives

·         Hi-Tech segment growth was muted due to cautious discretionary spending by clients amid macro headwinds

·         Infy is adapting itself to be 5G ready in India

·         Infy is seeing wage pressure/inflation in line with general inflation, but at the same time, there are reduced discounts or no discounts at all for its renewal of contracts

·         Infy is also trying to keep pricing power by demonstrating to clients the value of its digital technology

·         Infy is extremely bullish on Indian digital transformations and looking forward to working closely with government and private companies as appropriate; Infy is already implemented successful GST and IT platform for the government

·         The balance sheet continues to remain strong and debt free

·         FCF for Q2 was $589M which is 79% of net profits

·         Q2 FCF is generally low due to higher tax payout in both India and U.S.

·         To neutralize increasing employee cost pressure, Infy is adopting various cost optimization processes like rationalization of subcontractors, flattening of the pyramid, increasing automation, reducing onsite mix, and engaging with clients to increase pricing

·         Q2 subcontractor cost 10.1% of revenue, down by around -40 bps

·         Q2 utilization levels 83.6%; aim to increase to more comfortable 85% levels once demand picks up and able to put freshers rotate into various projects

·         No deal cancellations in Q2, but there was some slowness in projects involving discretionary spending involving mortgages, retail, telecom, and Hi-Tech

Finally, closing comments by Infy CEO Parekh:

In summary, first, we have both engines in our business digital and core growing which are very strong for us. Digital capabilities and Cobalt are resonating and core and automation we believe we have an industry-leading set of capabilities that makes us ready for the evolving macro environment. We had large deals of $2.7B which we are delighted with and we have a very strong margin performance of 21.5%. So margin is clearly part of our focus and we have a strong internal cost program that will help us drive all of these things. Attrition is coming down so we see a huge impact of the initiatives that we put in place some time ago. So overall we feel we have a good quarter and we are well positioned for the environment that is coming ahead in whichever scenario evolves in that environment.

Infy has a strong, debt-free, and cash-rich company. Looking ahead it can grow multifold through various organic and inorganic expansions and also growing digitalization moves in India (both at government and private levels).

Valuations: Rs.1790/- by Mar’23 and 2148/- by Mar’24

Infy reported a core operating EPS of 74.57 in FY22. Now considering past and current quarterly run rates, and various comments (pros & cons) as noted above, Infy may report a 20% CAGR on an average in core operating EPS growth in the coming days. And considering an average PE of 20, the fair value of Infy for FY: 22-26 may be around 1491-1790-2148-2577-3093. For Infy, differentiated digital and cloud capabilities should drive broad-based growth amid robust deal momentum. There are upside risks for Infy as it may even report a 30% growth in core operating EPS for FY23.

Rising investments in areas from cloud computing to cyber security by various corporates during the COVID pandemic have propped up demand for the $195 billion Indian IT industry. However, the demand has also led to severe attrition among employees and margins have suffered due to higher employee costs like wage hikes and additional travel and visa costs. Thus managing employees; i.e. attrition is now a huge challenge for Indian IT service companies like Infy. But the hybrid model of work should also optimize operating costs. Also, higher USDINR may support all exporters’ earnings including Infy despite some cross-currency headwinds.

Overall, Infy is a major beneficiary of global inflation/macro headwinds as companies are now embarking on cost-cutting/optimization by adopting greater automation, and digital and cloud adaption, which is Infy’s main growth engine. The market was skeptical about Infy’s performance amid synchronized economic slowdown on both sides of the Atlantic (U.S.-Europe), Infy’s primary market. Infy said although there are some concerns about discretionary tech spending, most companies are now upgrading their techs for cost optimization and to stay ahead of the curve/competitors.

Technical view: Infy (for short-term trading purposes)

Looking ahead, whatever may be the narrative, technically, Infy has to sustain over 1530 areas for 1555-1575 and 1635 and further higher levels as per the below table. On the flip side, sustaining below 1515 areas, it may further fall to 1475-1450-1415 and further lower levels to 1385-1355. Investors may accumulate around 1500/1415-1385/1355 zones which may act as a strong demand zone.

P/L account analysis:

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