Infosys
Infosys surprised the market by releasing less-than appealing first-quarter financial results, with weaker-than expected sales and a disconcerting jump in employee attrition the primary concerns. The company noted that its top line was affected by unanticipated headwinds in discretionary spending in consulting services and packaged implementations as well as slower project ramp-ups.
We believe most of the sales issues were self-inflicted and the macroeconomic uncertainty of Britain's exit from the European Union is yet to be realized, given management’s commentary on the quarter and Tata Consultancy Services' solid reported results. Brexit remains a large unknown at this early stage, and Infosys has said that it expects some cautiousness around spending in the short term. We would expect the financial services and insurance business to feel the brunt of any Brexit-related slowdown (FSI is about 33% of group revenue).
Given Infosys' first quarter, its visibility into the second quarter, and longer-dated macroeconomic uncertainty, the firm lowered its fiscal 2017 revenue growth guidance (in U.S. dollars) to 10.5%-12% from 11.5%-13.5% in constant currency.
We have slightly revised our model due to a more cautious outlook, but our fair value estimate is unchanged. We reiterate our Rs 1,177 ($17.70) fair value estimate and narrow economic moat rating. Even after the negative reaction to the first-quarter news and a notable pullback in the stock, Infosys is trading at only a small discount to our fair value estimate; we would recommend a wider margin of safety before investing in the firm.
For the quarter, revenue rose 10.9% year over year to $2.5 billion (12.1% in constant currency). Sequential industry growth was mixed, with manufacturing and high-tech as well as energy and utilities, communications, and services outperforming FSI and retail, logistics, CPG and life sciences.
Next-generation digital services remain a high priority, and Infosys highlighted the launch of Infosys Mana, a knowledge-based AI platform to help with automation and innovation. The firm also noted that over 100,000 employees had been trained in design thinking (to assist with the move to digital-related services), which should help it navigate shifting spending trends in the IT services industry.
However, we are concerned with Infosys’ rising employee attrition rate. On an annualized basis, it jumped to 21.0% from 17.3% last quarter. Some of this increase is attributable to seasonal effects, but it’s still too high for our liking; we would like to see attrition come back into the mid- to high teens. The firm did announce an employee stock ownership plan after a 13-year hiatus, which could help alleviate the high rate of attrition. As a result, we will keep a keen eye on attrition over the coming quarters.
The firm’s first-quarter operating margin was 24.1%, up 10 basis points year over year. We continue to forecast medium-term operating margins of 24%-26% as Infosys balances compensation increases with better workforce utilization, less subcontractor spending, and automation.
