Infosys Ltd
We expect Dr. Vishal Sikka, the company’s newly appointed CEO, to improve Infosys’ slow-moving legacy past, and early signs are promising, with revenue, margins, and attrition improving. Strategically, Sikka highlighted automation, artificial intelligence (AI), and skilled human capital as critical success factors from which Infosys can drive higher productivity and deeper market relevance.
While not a surprising anecdote from the new manager, the firm expects to supplement organic investments in automation and AI with mergers and acquisitions, while keeping the company’s relatively high attrition rate in check. We expect improved long-term revenue growth as a result. After the introduction of several initiatives, month-to-month attrition rates have begun to fall, which is an encouraging sign.
We think Infosys remains highly relevant in the market even though Finacle (its core banking platform) experienced some weakness and point to seven significant wins in the quarter that totaled $600 million across various industries. Under new management, we think Infosys can return to its market-leading position and that the early signs are promising. Still, some execution risks remain as the firm looks reinvigorate growth and to shift to next-generation products and services.
Economic Moat: Narrow
Infosys' narrow moat stems from its scale, comprehensive service portfolio, and strong network of clients. With a wide variety of vendor services available, large companies are looking beyond cost when determining their IT service providers. Factors that play a role in vendor selection include company size, reputation, breadth, and depth of domain knowledge. Infosys, with its global reach, solid reputation, and leading market position, has carved a niche for itself in offshore IT services. Infosys also benefits from entrenched relationships with its customers. The company has established a solid record of building and nurturing client relationships (about 775 active clients), an essential trait required to survive in the highly competitive IT services industry. Repeat business accounts for about 98% of Infosys' total revenue.
Fair Value Estimate: Rs 3,700
Although we still expect the company to continue to face modest headwinds in the near term as it attempts to strike a fine balance between revenue growth and operating margins, execution as-of late has been good. In the past, Infosys was known for its rigid stand on pricing, which severely hurt its top-line growth. In an effort to arrest the slide and drive growth, Infosys has been more flexible in its negotiation with clients on contract structures. The change in stance should help drive growth at Infosys in the future.
Overall, we forecast Infosys' revenue to grow at a compound annual rate of 10% over the next five years.
We expect to see a gradual contraction in Infosys' operating margins as the company succumbs to pricing pressure from customers and competitors. We also expect the firm to face some headwinds from wage inflation.
However, the company's flexible operating model should help partially offset the negative impact from wage inflation and lower pricing. We forecast operating margins to compress by about 250 basis points during our five-year forecast period. We think the new normal for Infosys will be operating margins in the mid-20s, down from its historical high-20s level.
Risk
Infosys is exposed to cyclical downturns in technology spending. An economic slowdown may force clients to delay or reduce their IT spending, which would lower the demand for Infosys' services. The company's revenue and margins would be hurt if the Indian rupee were to appreciate strongly against the U.S. dollar.
To view a detailed analysis of Infosys, click here.
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