Infy tumbled after Q4FY22 subdued report card; what’s next?

Infy tumbled on mixed guidance coupled with below expected revenue and operating margin, but the plunge may be a good opportunity to enter a blue-chip in adversity

Infy tumbled almost -20% and made an almost 11-month low around 1531.00 Monday amid subdued Q4FY22 report card, mixed guidance, and as the Indian Labor Ministry summoned the company officials over a non-compete clause for its employees. Infy as-well-as other IT blue chips were already under pressure in line with tech-heavy Nasdaq as the COVID pandemic has now turned into endemic and the days of WFH/WFA are almost over. Like all tech companies, Infy is also a prime beneficiary of the COVID lockdown-led digital world and the part & parcel of ‘K’-shaped economic recovery post COVID world, unlike the consumer-facing service industry.

During COVID, the world survives on remote working/digital technology. But now after COVID, as the economy, society, and workplaces open almost fully, WFH/WFA is not required. But at the same time, WFO is now also not mandatory, it’s optional. Globally, there is a trend of WFH/WFA for better productivity, convenience, time & cost saving even after COVID and thus the hybrid model of work (mixed of WFH/WFO) will be the norm with emphasis on WFH where it’s feasible. Thus the appeal of WFH/WFA and techs will be always there even after COVID.

Another reason for the tech/NASDAQ slump from the post-COVID high is lingering supply chain disruptions/chip shortages due to COVID. The market is now concerned about prolonged supply chain disruptions in the coming quarters amid Chinese COVID lockdowns (under zero COVID policy) and the prolonged Russia-Ukraine war. As Infy and other Indian IT service providers have significant contractual/service work with global tech giants, any slowdown in the U.S., European techs bound to affect Indian IT service providers such as Infy, TCS, Wipro, Tech Mahindra, etc.

Infosys (INFY) is an information services company and its 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’s products, business platforms, and solutions to 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. Overall, financial service is Infy’s bread & butter, and North America and Europe are its main market as almost 85% of revenue come from there.

Although the U.S. economy may not be directly affected too much by the Russia-Ukraine/NATO war/proxy war, the European economy has been already affected due to over-dependence on Russian oil & gas and other commodities coupled with some exposure to EU/European banking/financial system with Russia. In brief, Europe is significantly affected due to the lingering proxy war between Russia-Ukraine/NATO and subsequent economic and other sanctions. Almost 24% of Infy’s revenue comes from Europe and thus any European woes are also negative for the company. The current geopolitical tension involving Eastern Europe also makes it harder for Indian IT service companies such as Infy, TCS, Wipro, and Tech Mahindra to find talented software brains at a reasonable cost from that region.

In Q4FY22, Infy reported a subdued set of numbers sequentially (q/q), although it may be a blockbuster on a yearly (y/y) basis.

Infy reported +1.28% sequential growth in revenue while operating expenses surged +4.02% amid higher employee compensation, benefits, and higher traveling costs as the economy has opened. Thus the EBITDA fell -by 6.41% sequentially, while EBTDA (after interest) slips -by 6.41%. Eventually core operating EPS (EBTDA/Share) came at 18.58 vs 19.86 sequentially (-6.46%) and 17.00 yearly (+9.30%). The EBTDA margin was 24.15% vs 26.14% sequentially and 27.44% yearly, while the EBITDA margin was 24.31% vs 26.31% sequentially and 27.63% yearly. Infy also issued guidance of around 13-15% revenue growths for FY23 and 21-23% of operating profit margin (in CC).

Although revenue guidance was better than market expectations (12-14%), margin guidance was below market estimate (22-24%). Infy tumbled on mixed guidance coupled with below expected revenue in Q4FY22 and a lower operating margin.

Highlights of Infy statement on FY22 and Q4FY22 report card:

·         In CC (constant currency), the FY22 revenue was $16.3B; up +19.7% annually and highest growth in the last decade against guidance 12-14%

·         Operating margin robust +23.0% in CC for FY22, declines -1.5% annually; guidance 21-23%

·         INR revenue growth +21.1% annually for FY22

·         For FY22, digital revenue57% of total revenues; annual growth +41.2% in CC

·         FY22 basic EPS at Rs.52.52; growth +15.2% (y/y)

·         FCF at Rs.22.803B, growth +3.6% (y/y); FCF conversion at 103.0% of net profit

·         Growth was broad-based, supported by continued momentum in large deal wins with TCV of $9.5 billion; EPS grew by 15.2%

·         In rupee terms. FCF crossed $3 billion for the year

·         The Q4 sequential growth was 1.2% in constant currency with operating margin of 21.5%

·         TCV of large deal wins was $2.3 billion in Q4

·         Q4FY22 revenues grew by +20.6% yearly (y/y) and +1.2% sequentially in CC

·         Q4FY22 INR revenue Rs.32.276B, growth +22.7% (y/y)

·         Q4FY22 Digital revenues 59.2% of total revenues; yearly growth +38.8% in CC

·         Operating margin at 21.5%; down -3% (y/y)

·         Basic EPS 13.56; up +13.4% (y/y)

·         FCF at Rs.5.769B; down -0.9% (y/y); FCF conversion at 101.3% of net profit

·         Guidance: Revenue growth of 13%-15% in constant currency; Operating margin of 21%-23%

The Infy CEO and MD Parekh said:

“Infosys delivered highest annual growth in a decade with broad-based performance driven by deeply differentiated digital and Infosys Cobalt led cloud capabilities, powered by ‘One Infosys’ approach. We continue to gain market share as a result of sustained clients’ confidence in our ability to successfully navigate their digital journeys. With the acceleration of digital disruptions across industries, we see immense potential to engage and partner with clients as they transform, adapt, and thrive. We will scale talent globally, invest in employees and accelerate innovation and digital capabilities to capitalize on the expanding market opportunity.

We have had an exceptional year; this year with an annual growth of 19.7% in constant currency terms. This was the fastest growth that we have had in 11 years. We are gaining market share; we are building on our leadership in cloud and digital and we are working more closely with clients on their transformation programs. Growth was broad-based across business segments, service lines, and geographies. Each of our business segments grew in the double digits, the US and Europe grew 20%, so a very strong performance all around.

Our digital revenues now account for 59.2% of our company and they grew at 41.2% for the year. Within digital, our cloud work is growing faster, and our Cobalt cloud capabilities are seeing significant traction with our clients. Our growth has been accompanied by robust operating margins at 23%. We delivered these margins while maintaining focus on our employees with increased compensation and benefits.

Our large deal wins were at $9.5 bn for the full year and $2.3 bn for the quarter. In Q4 our revenue growth was 20.6% year on year and 1.2% quarter on quarter in constant currency terms. Our industry-leading performance in FY22 would not have been possible without the enormous contribution and commitment of all of our employees. I am extremely proud and grateful for the extraordinary efforts in delivering all the work for our clients.

We recruited 85,000 college graduates this financial year. We added 22,000 employees in the fourth quarter. We have an extremely strong recruitment program; this is really a reflection of our enhanced recruitment capabilities, solid brand, and deep penetration into various talent markets. This increases our comfort to support our clients in their digital transformation programs. As we look ahead, our sustained momentum in FY 22, large deal wins, robust deal pipeline and client confidence in our capabilities give us comfort to provide a guidance of 13% to 15% for growth in FY23, in constant currency terms.

With the pace of digital disruption accelerating across industries, we see a robust demand environment and immense potential to partner with our clients. Our ‘One Infosys’ approach is serving us well to bring the best of Infosys in the service of our clients’ needs. Our strategy that we launched four years ago has really served us well. We have delivered industry-leading growth and industry-leading TSR.

Now as we look ahead to the next phase, we want to further enhance our leadership along the digital innovation curve. We plan to expand the capabilities by scaling our cloud capabilities even further, expanding our digital work, expanding on our automation, increasing relevance with large enterprises and the technology native companies, and strengthening our employee value proposition. Our focus on staying ahead in the cloud and digital ecosystem, the focus on employees, and some of the costs which are coming back after the COVID phase are behind us; resulting in operating margin guidance to be at 21% to 23% for FY23.

The Infy CFO Roy said: “In a year marked by intense supply-side challenges, Infosys delivered strong financial performance –EPS growth of 15.2%, Free Cash Flows surpassing $3 billion and Return on Equity of 29.1%, reflecting the company’s success, driven by client-centricity and rich capabilities. The Board has proposed a final dividend of ₹16 per share, taking the total dividend for FY22 to ₹31 per share, an increase of 14.8% over the prior year. With a robust demand environment ahead, we envisage making appropriate long-term investments in capability building across sales, delivery, and innovation. However, we plan to neutralize some of the impacts through aggressive cost optimization programs and value-led pricing driven by service and brand differentiation. This, along with post-pandemic normalization of expenses, is reflected in the margin guidance”.

Highlights of Q&A sessions in analyst concall:

·         Infy clocked higher revenue growths of +19.7% in FY22 than earlier guidance of 12-14% (in CC)

·         For FY23, Infy is confident of meeting revenue growth guidance of 13-15% (in CC) despite a subdued global economic outlook amid the lingering Russia-Ukraine geopolitical conflict. Infy relies on digital tech transformation-related robust client demands, large deals in pipelines, and employee/talent strength. But Infy may again review the revenue guidance in the coming quarters based on underlying geopolitical/economical situations

·         For Q4FY22, Infy delivered a 23% operating margin (in CC) against the guidance of 22-24%; down almost -1.5% (y/y); the lower margin was due to lower utilization from 88.5% to 87% in Q4FY22 as the company was uncomfortable at 88.5% utilization levels.

·         For Q4FY22, in terms of revenues by geographies (in CC terms), the North American market (61% of the mix), grew 18.1% YoY while Europe and India reported growth of +22.3% and 26.4% YoY, respectively; the ROW region grew 9.8% (y/y)

·         For Q4FY22, vertical wise (in CC terms): BFSI (31% of mix), retail (14.3% mix) & Communication (12.8% of mix) grew 14.1%, 16.5% and 29.2%, while energy, manufacturing, hi-tech grew 17.8%, 50.6% and 20.9% respectively (y/y)

·         Lower margin also for higher employee costs and travel expenses as the economy opens up after COVID

·         The E-commerce platform is doing well

·         Infy has little exposure in Russia, where a client service center was functioning with less than 100 employees to serve some global clients (in Russia); Infy has no Russian clients and is shifting that client service center along with existing employees outside Russia to other East European locations; Infy has no plan to do business with any Russian client going forward

·         Company and clients are excited about a new platform called Metaverse Foundry, which is a platform especially for servicing the manufacturing sector

·         Infy provided very strong guidance for FY23 and is confident to meet the same

·         Attrition levels in Infy are now stabilizing fast and also recovering due to a change in HR/hiring strategy including the permission of permanent WFH/WFA or a hybrid model of work; some companies/industries do require WFO (Work from the office) for data security and thus Infy is flexible with WFH/WFA/WFO; now around 95% of employee are working remotely

·         Infy is expanding to other Eastern European countries like Poland and Romania

·         Subdued revenge and margin in Q4FY22 was a one-off event related to the contractual situation and higher employee-related costs after COVID

·         The company is discussing with clients for revised/higher billing amid input cost pressure/inflation including higher employee wages/compensation

·         Infy is very confident of meeting strong guidance amid the digital transformation of clients and employee strength; there is a very robust demand environment and the company has to capture that by technological innovation, higher utilization, and ramping up hiring with emphasis on fresher

·         Clients have no problem spending higher on digital tech, cloud area, data analytics, IoT, and other aspects of automation for better productivity, cost-cutting, and efficiency

·         As of now, no major impact on European business because of the Russia-Ukraine war

Valuations: Rs.1790-2148 by Mar’23

Infy reported a core operating EPS of 74.57 in FY22. Now considering past and current quarterly run rates, and various comments as above, Infy may report a 20% CAGR on an average in core operating EPS growth. And considering an average PE of 20, the fair value of Infy for FY: 22-26 may be around 1491-1790-2148-2577. For Infy, differentiated digital and cloud capabilities should drive broad-based growth amid robust deal momentum.

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 the Indian IT service companies like Infy. But the hybrid model of work should also optimize operating costs. Also higher USDINR and even EURINR amid growing policy divergence between RBI and Fed/ECB may support exporter’s earnings including Infy.

Looking ahead, whatever may be the narrative, technically, Infy has to sustain over 1530 areas; otherwise, it may further fall to 1500-1475 zones, which may be a strong demand zone. Investors may accumulate Infy amid tech adversity around 1530-1500-1475 areas.

Technical view: Infy (for short term trading purposes)

P&L A/C analysis: Infy

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