All cloud, no silver lining for Infosys

Both information technology (IT) services firms saw business activity slowdown in the key market of North America. Unplanned project ramp downs, delays in decision making and one-off impact due to certain cancellations hit revenue growth, the Infosys management said. Demand weakness was broad-based across financial services, telecom and high-tech verticals.

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Remember, just in January, Infosys had raised its FY23 CC revenue growth guidance to 16-16.5% from 15-16% earlier. But evidently, the scenario didn’t pan out as expected with the company missing its guidance after clocking 15.4% CC revenue growth. “While the US macro had been deteriorating all through CY22, Infosys’s management was holding out hope likely on its interactions with clients and deal flow. In a sudden turn of events, worse than that for TCS, March ’23 quarter has seen deferments and cancellation of projects,” Girish Pai, head of research at Nirmal Bang Institutional Equities wrote in a report.

Management commentary of IT companies in the previous quarters was largely upbeat on the demand outlook even as broader global economic trends were subdued. This disconnect was a key factor that kept investors guessing on what lies ahead for the sector. But Infosys’s results could bring a reality check to investors. What’s more, Infosys’s FY24 CC growth guidance at 4-7% is muted, too. “The upper end seems ambitious as we believe the worst on the US macro front is ahead of us and not behind us. If customers behave like this in 4QFY23 when the US economy has been resilient, we wonder how they would react when the economy actually turns down,” added Pai.

Infosys’ large deal total contract value at $2.1 billion fell 8% year-on-year in Q4. However, the deal pipeline is strong, including several mega deals, said the Infosys management. But note that large deals usually take more time to convert, so revenue growth may not get an immediate boost. Consequently, meeting the upper end of this band seems like a tall task. “Mega deal closures beyond Q1FY24 are unlikely to aid revenue performance meaningfully. Overall, the top end of the guidance requires a very strong H1, which we believe the consensus is unlikely to assume,” Investec Capital Services (India) said in a note.

Coming to Q4, lower utilizations due to project cancellations were a headache. Infosys’s earnings before interest and taxes (Ebit) margin fell by 50 basis points sequentially to 21%. Infosys has guided for FY24 Ebit margin at 20-22%, lower than analysts’ expectations and despite potential margin levers such as optimization of sub-contracting costs.

It is hardly surprising that brokerages have cut Infosys’s earnings per share estimates for FY24 and FY25. Some have lowered their ratings on the stock. The risk of a further de-rating has become more pronounced not only for Infosys, but for the entire IT pack. “To keep investors’ interest intact, we may see IT companies announcing higher dividends and buybacks, but now, negatives are outweighing positives, so that move is unlikely to work,” said Omkar Tanksale, senior research analyst at Axis Securities. Naturally, this would have a bearing on valuations. Shares of Infosys and TCS trade at 19.4x and 22.90x FY25 estimated earnings, respectively, showed Bloomberg data. Post Q4 results, expectations on Infosys’s growth would taper and its valuation discount to TCS is expected to increase. As Tanksale points out, “Infosys valuations would come down, thus widening the gap between TCS and Infosys valuation multiple.”