Is the bad patch over for Infosys?

Markets react favorably to better than expected results.

By R. Chandrasekaran

BANGALORE: It may seem that India’s second biggest software exporter and technology bellwether Infosys has come out of a bad patch going by the first quarter results and the confidence in retaining its outlook for the fiscal year. However, how it goes forward from here will determine whether the worst is over for Bangalore’s iconic company.

The stock market reacted very positively to the quarterly numbers and the guidance by lifting the stock price as much as 15 percent at one point of time during the trading immediately after the results announcement.

Why did the markets react so favorably to the quarterly results? Are the results very strong to suggest the worst is over? Has the company overcome the execution problem? Has it changed its strategy? Has it improved its margin or pricing? Has N.R. Narayanamurthy’s presence boosted the confidence of the sales force? There could be more questions like this. But the answer for all these questions is quite simple.

Most of the analysts and investors predicted the company would have muted results. They also estimated Infosys to deliver below industry level only. When a company delivers results that are slightly above expectations, it is greeted with much fan fare as they feared more unfavorable news from the company.

More than any big favorable factors, there were less worrying factors that contributed to the renewed interest in the company. For instance, sales on USD basis advanced 2.7 percent on a sequential basis and 13.6 percent on a year-over-year basis at $1.99 billion for the first quarter. The growth is much higher than the Street had expected between flat and 1 percent growth.

Profit, on the other hand, shrunk 5.9 percent from March quarter though there was a slender 0.5 percent growth from the last year to $418 million or EPS of 73 cents, which came in line with Wall Street predictions.

While the market was expecting Infosys’ operating margin to get pressured more, especially after the recent pay hike, it reported 23.5 percent, which is ten basis points higher than the Street estimates. However, the company’s chief financial officer Bansal cautioned that operating margin will get hit by three percentage points in the second quarter and 2.4 percentage points in the fiscal year ended March 2014 due to pay hikes.

Similarly, the company retained its USD annual revenue guidance of 6 – 10 percent, whereas the market predicted the company to lower USD outlook by at least two percentage points. However, the revenue outlook is lower than the National Association of Software Service Companies (NASSCOM) expectations of 12 – 14 percent growth.

One may argue that analysts and market experts had kept their numbers lower given the trouble that Infosys had faced in the execution in the past; but no one could deny the fact that there are some positives from the results.

For instance, if the company could achieve better than expected growth in revenue, it is primarily due to 4.9 percent sequential growth in North America. This translated into 1.2 percentage point increase in revenue contribution to the overall top line performance. Infosys generated 61.4 percent of its revenue from North America in the first quarter compared to 60.2 percent in the fourth quarter though it is lower than the year-ago quarter’s 64.1 percent. Significantly, North America’s contribution is closer to last twelve-month period’s 61.6 percent.

Similarly, volume witnessed 3.4 percent growth sequentially compared to 1.8 percent recorded in the preceding quarter driven by 1.8 percent rise in IT services.

If the fall in Europe’s contribution to total revenue is compensated, it was because of the growth in North America as well as volume. The region’s revenue represented only 23.6 percent, down from 25 percent in the March quarter though it was up from 21.4 percent from the year-ago period.

Business from India also grew 10.4 percent, but this translated into a mere 20 basis points increase in lifting its contribution to the over all revenue.

Commenting on the results, Infosys CEO and Managing Director S.D. Shibulal said, “despite facing an uncertain macro environment, changing regulatory regime and a volatile currency environment, we have done well in Q1 and are cautiously optimistic about rest of the year.”

Meanwhile, SMC Global Securities Equity Head Jagannadham Thunuguntla  reportedly commented, “A number of factors seems to have worked in their favor including a weaker Rupee, Murthy coming back at the helm and the U.S. economy looking up a bit. The stock was trading at a sharp discount to its peers on P/E multiples and this is the push the stock needed.”

Looking at the results and the comments, it is premature to say that the company’s bad patch is over. Only a month back, Narayanamurthy sought three years to bring back the company to its past glory. At least one more strong quarter is needed before saying that the worst is over. To be a leader, it needs to go further in delivering what investors expect. However, the positive from the result is that the company is trying to gain from the improved conditions in the U.S. since it depends heavily on it.

The impact of Narayanamurthy could also be felt only during the second quarter and therefore it is too early to talk about his contribution. His presence could boost the sentiments among investors and confidence among its employees. There could also be more changes in the management with old-timers like V. Balakrishnan likely to return.

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