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Infosys Reports

It’s a good set of numbers because we have got a big earning surprise at Rs 1,079 crore. Those numbers are way above our expectations at Rs 975 crore but the revenue numbers are absolutely flat between quarters. There could be a lot of other income, which we were expecting in any case, because of the big hedges that were taken by Infosys.

The profit numbers are whole lot higher than our expectations but the sales numbers are lower than our expectations. The rupee has certainly hurt this quarter. They have managed to deliver Rs 1,079 crore this quarter as against Rs 1,020 crore in the corresponding previous quarter, if you take out the tax right back. Without the tax right back, there is actually been an about 4-5% jump in sequential profits.

If you take the reported numbers from Rs 1,144 crore including the tax right back, you will see a marginal slip in net profit sequentially. A 5% jump in sequential profits without the tax right back is a very impressive set of numbers. There will be a lot of hedging profits out there, which has boosted other income.

The topline number is not terribly encouraging. We were expecting about Rs 3,813 crore and they have kicked in at Rs 3,773 crore. They are about Rs 40 crore odd lower than our expectations. It is flattish or 1% down sequentially on the revenue side.

On the profit picture, they have done far better. If this is the case then they might actually not have to lower their full year guidance and that’s exactly what the market will be focused on. Profits at Rs 1,079 crore raise hopes that maybe Infosys will not need to lower their guidance for the full year. There is a surprise on the bottomline, there is no getting away from that.

I think you will see a lot of other income out there. I don’t think with a flat revenue picture between quarters, there is any great operating margin expansion or lower than expected operating margin dip, which could have resulted in this profit figure. So 1,079 crore is a big surprise and I think it adds about a rupee-and-a-half to earnings per share. This means that Infosys may not struggle to keep its full-year guidance of Rs 80-81.

There were fears that they could actually do between Rs 950 and Rs 975 crore because of that slippage of Rs 100-150 crore and you could see them going extremely conservative on the full year. They may still chose to do that but I think the chances are much higher now. They may not need to lower the guidance for the full year because these numbers have come in on the higher end of expectations.

There will be damage on margins and there is no of getting away from that. I think the street might have underestimated the other income and that might come in much higher than expectations. We were expecting just under Rs 150 crore in other income. I would not be surprised if we have more than Rs 200 crore of other income because of the high amount of hedging and hedging profits, which may have come in.

If you look at the revenue picture between quarters, it tells you that the picture has not been great in this quarter. In fact, Infosys has missed its guidance for revenues this quarter and that itself is a very telling comment. There were expectations that it would have clocked 8-9% volume growth. To have negated that entire volume growth because of the rupee, tells you that it has been not a good picture. We probably will see quite a bit of operating margin pressure, maybe more than 300 bps as well. We will wait and see if this is good enough for Infosys to hold its full year guidance of Rs 80-81.

Infy’s results have come at a time when the overall global markets’ pace is a little weak this morning. I am wondering how the pulls and pressures will work out because there is a big sell-off in the US and some lukewarm movements in the Asian markets. Yesterday, the markets did not close very well.

On global markets:

The Asian markets’ sell-off is not extremely acute this morning. Most markets are down between half a percent and two-thirds of a percent. I don't think that qualifies as a big 1.5-2% sell-off. The cues are not great but they are not too terrible.

Infosys Technologies has announced its first quarter results. The company has reported consolidated net profit of Rs 1079 crore (including tax write back) in the first quarter of FY08 as against Rs 1,144 crore in the previous quarter, down 5.68%, which is above the market expectations.

According to the management the revenue has been impacted by Rs 287 crore due to rupee rise. "If you look at the quarter itself we have had a strong sequential growth at 7.5% on topline in the US gaap terms. We had 6.9% volume growth which is very strong" adds CEO & MD at Infosys, S Gopalakrishnan.

Margins impacted by Rupee appreciation:

Rupee appreciation has impacted the margins by 3.5% whereas EBITDA margins may be hit by 100-200 bps in FY08. In this quarter, revenues were impacted by Rs 287 crore because of the rupee appreciation but Inspite of it, the volume growth is still very strong at 6.9%.

Chief Financial Officer, V Balakrishnan says that the company should be able to maintain the margins in the narrow band compared to last year. He adds that the rupee guidance have been revised for the full year having lost Rs 287 crore in revenues of the first quarter due to rupee movement.

European portfolio growing up faster than the US portfolio:

"We grew in North America by about 7.5%, and in Europe by almost 8.5%. We have grown across all sectors whether it is BFSI, telecom, transportation,logistics, services, consulting, BPO and testing. So the growth actually is very broad" points Gopalakrishnan.

On the portfolio management front, the European portfolio has been growing up faster than the US portfolio and it has reached 26.8% this quarter. They have high margin or high revenue product to services for example consulting, which grew by almost 22% quarter on quarter, and is about 4.9% of the revenue, whereas package implementation is 18.4%. "So there are multiple services which we can manage to extract better value and revenue product from different clients so we actively do this to make sure that our revenue productivity goes up" he says.

Our guidance is based on our visibility :

The company also sees 9.3% growth in non top-10 clients and has added 35 new clients. They also add that any pricing increases would impact FY08 guidance positively."We are looking at 26,000 employees to be added for the year" adds Gopalakrishnan. The employee utilization, including trainees, is up 260 bps to 70.5% and the attrition rate is at 13.7%.

The management added that the wage cost is up 2.5% and the visa cost is up 1%. The offshore wages are up 12-15%, while the onsite wages are up 5-6%.

"We continue to try and extract value from our clients so you can see our revenue product has gone up quarter on quarter last year 5% and this quarter 1%". informs COO, S D Shibulal.

BPO margins down from 21-22% to 16-17%:

The earlier margins of 21-22% have come down to 16-17% margins in the BPO business, this quarter.The BPO has grown; the company added 2,000 people and lost 1,000 people, Mohandas Pai, Director, HR, informed.

The management said that appreciating rupee could significantly impact the BPO business. They added that the tax sops for BPOs should continue for the next 5 years.

Infy has already factored in a rupee exchange at 40.58. In the short-term, it sees rupee moving between USD 39-41. The appreciating rupee could significantly impact the company’s BPO business.

"BPO companies do not have a natural hedge in terms of foreign currency expenses, at least the IT industry has got some natural hedge because they have foreign currency expenses; so it is a big impact on BPO companies. I think there should be something done at that side, because a currency appreciation will have impact and looking at what is happening today in India, currency could appreciate further," Balakrishnan said.

Infosys which is known for positive surprises has once again beaten the market expectations and posted consolidated net profit of Rs 1079 crore (including tax write back) in the first quarter of FY08 against Rs 1,144 crore in the previous quarter.

How is the market reading the Infosys numbers? Most experts believe that the pressure will continue, are scaling down their price targets and earnings expectations.

Nilesh Shah of Envision Capital says that Infosys is fairly valued at current market price. The case for contraction of premiums is enjoyed by tier-I IT companies he adds. He feels that the IT sector will underperform in the next 2 quarters

JP Sinha of Ambit Capital says that the tech sector can underperform in the short-term.

Further on, Ashwin Mehta, Analyst at Ambit Capital said that the brokerage firm was looking at three things when the Infosys management spoke. Revival of revenues via Banking, Financial Services and Insurance was one of them and that has happened. The second point was increase in utilisation, which too had happened to almost 260 basis points. The third thing was the guidance that his firm was expecting downgrade of the guidance to Rs 77 to Rs 78 and that has happened.

"In terms of our estimates Infy is expected to do somewhere in the range of Rs 80 this year and around Rs 95-96 next year. At a 23 times multiple, it would trade at somewhere in the range of Rs 2200 one year down the line," Mehta said.

Dipan Mehta, Member, BSE & NSE says that Infy growth may slow down to 7% due to rupee.

Vibhav Kapoor of IL&FS says:

Infosys FY08 guidance of Rs 78-79 is in line with market expectations. We need some more clarity on the other income component. Overall, the business seems to be doing well & I expect the company will beat full year guidance. A bounce is expected in the Infosys stock as there could be some short covering. The stock should settle between Rs 2,000-2,100 in the short-term.

Devesh Kumar of Centrum Finance says:

Infosys' muted earnings guidance will not go down well with the markets. I expect the stock to correct. Sentiment for all dollar driven cos may turn negative post the Infosys guidance.

While, the FII view on this comes from Moshe Katri, MD at Cowen and Company. he said that the downward revision of rupee guidance is the biggest overhang for the stock today. Though, Infosys fundamentals remain strong. He sees Infosys operation metrics as better than last quarters.

DSP Merrill Lynch says:

EPS for FY08 is expected at Rs 82. Profit after tax, or PAT, is higher than expected on higher income from other businesses. Was expecting higher dollar-revenue.

JPMorgan says:

Q1 result is in line. Buy Infosys in the current weakness. Infosys stock will react negatively given the lower-than-expected FY08 guidance due to the management’s conservative stance. This guidance does not reflect any weakness in business trend at Infosys.

There would be positive surprises as the company moves into the traditionally stronger quarters. JP Morgan expects 40% plus dollar-based growth which includes 25% plus Re-based revenue growth and 30% plus dollar-based EPS growth.

CLSA says:

Infosys may remain sluggish till the October results when the next test of estimates and upsides will happen. Dollar-revenue in June quarter is much below the street estimates. The lack of revenue upside is key negative surprise of Q1FY08. Q1 results and outlook are unlikely to push estimates up.

From tech pack, CLSA expects Cognizant and Satyam to do better.

Angel Broking’s Harit Shah says:

I was disappointed with the kind of flat revenue growth that they have given plus the significant downgrade in the rupee-revenue guidance. But overall the result has been inline. As far as business growth is concerned, there is no problem; there are a 38-40% growth in dollar terms on YoY basis in revenues. On the volume side, there is about 7% sequential volume growth this quarter and over 30% on a YoY basis.

The disappointing factor was on the downgrade in rupee guidance as well as the downgrade in the EPS. But overall the company should be able to do about Rs 80-Rs 82 kind of a range in FY08.

Sanjeev Hota, IT analyst of Emkay says:

In revenue terms, it’s marginally below our expectations, but in the net profitability term, it is higher than our expectations. I am expecting an EPS of Rs 82 for FY08 from an earlier EPS of Rs 87 per share. Earlier we had a price target of Rs 2616 and we might revise it to Rs 2400.

It’s definitely going to be a buy from our side but it is going to be sluggish till the second quarter results. The second quarter has always been a very good quarter for Infy. Right now if you have taken a rupee rate of 40.5, if the rupee start depreciating, then Infy might revise its guidance upwards from the second quarter.

We believe that the margins are going to stabilize because this time the margin fall was driven by the improvement in the utilization rate. We expect the billing rate to improve in the next three quarters and the margins are going to stabilize around 29% for the full year.

Infosys Technologies, which is known for positive surprises has once again beaten the market expectations and posted consolidated net profit of Rs 1079 crore (including tax write back) in the first quarter of FY08 against Rs 1,144 crore in the previous quarter.

Infosys Q2 and FY08 guidance

The company is expected to post growth of 16.9-18.3% in the revenues in FY08 at Rs 16,238-16,433 crore. Infosys is expected to deliver growth of 13-14.1% in FY08 EPS at Rs 78.20-79.

FY08 EPS (Excluding tax write back) is seen at Rs 77.31-78.11.

This FY08 revenue outlook is based on rupee rate of 40.58 per USD.

The Q2 revenues are seen at Rs 3,952-3,993 crore, a growth of 4.74-5.83% and EPS seen at Rs 18.88. Net profit is expected to go down 0.05% at Rs 1078 crore.

Infosys revised guidance in the dollar terms in upward and in Rupee terms down.

It is going to add 26,000 employees in FY08

Infosys Technologies has announced the Business Outlook. Its outlook (consolidated) for the quarter ending September 30, 2007 and the fiscal year ending March 31, 2008, under Indian GAAP and US GAAP, is as follows:

Outlook under Indian GAAP consolidated:

Quarter ending September 30, 2007:

Income is expected to be in the range of Rs 39,520 million and Rs 39,930 million; YoY growth of 14.5% 15.7%. Earnings per share is expected to be Rs 18.88; YoY growth of 12.7%.

Fiscal year ending March 31, 2008:

Income is expected to be in the range of Rs 162,380 million and Rs 164,330 million; YoY growth of 16.9% 18.3%. Earnings per share are expected to be between Rs 78.20 and Rs 79; YoY growth of 13.0% 14.1%; including tax reversal of Rs 510 million and Rs 1240 million in fiscal 2008 and 2007 respectively. Excluding the tax reversal the Earnings per share are expected to be between Rs 77.31 and Rs 78.11; YoY growth of 15.6% to 16.8%.

Conversion 1 US$ = Rs 40.58


Outlook under US GAAP:

Quarter ending September 30, 2007:

Consolidated revenues are expected to be in the range of $ 974 million and $ 984 million; YoY growth of 30.6% 31.9%. Consolidated earnings per American Depositary Share are expected to be $ 0.46; YoY growth of 27.8%.

Fiscal year ending March 31, 2008:

Consolidated revenues are expected to be in the range of $ 4.00 billion and $ 4.05 billion; YoY growth of 29% 31%. Consolidated earnings per American Depositary Share are expected to be between $ 1.92 and $ 1.94; YoY growth of 25.5% 26.8% including tax reversal of US$ 13 million and US$ 29 million in fiscal 2008 and 2007 respectively. Excluding the tax reversals the consolidated Earnings per American Depositary Shares are expected to be between $ 1.90 to $ 1.92; YoY growth of 28.4% to 29.7%.

As clients recognize the strategic imperative of global sourcing in an increasingly flat business world, the demand for large end-to-end players like Infosys continues to be strong, said S. Gopalakrishnan, CEO and Managing Director. We continue to focus on being a partner of choice to our customers.

Infosys guidance for FY08: Revenue growth is seen at Rs 16,238-16,433 crore, up 16.9-18.3%. FY08 EPS (Excl Tax Write Back) is seen at Rs 77.31-78.11. FY08 Revenue Outlook is based on rupee rate of 40.58/$. FY08 Rupee Guidance has been revised downwards. The Q2 revenues are seen at Rs 3952-3993 crore.Q2 EPS is seen at Rs 18.88.

Today Infosys announced its results. The Q1FY08 (QoQ) Net Profit is down 5.68% to Rs 1079 crore from Rs 1144# crore. CNBC-TV18 Estimates saw the figure at Rs 974.48 crore.
# including tax write back

The Q1FY08 (QoQ) revenues are up 0.02% to Rs 3773 crore from Rs 3772 crore. CNBC-TV18 estimates saw the figure at Rs 3813 crore. Infosys had given Q1 revenue guidance of Rs 3,896-3,913 crore. It had given Q1 Net Profit guidance of Rs 1,005.37 crore.

In Q1, the company added 35 New Clients and added 3,730 employees. Infosys CEO Says demand for large end-to-end players like Infy is still strong. Q1 Other Income is at Rs 253 crore vs Rs 119 crore (QoQ). Q1 OPM was at 28.7% vs 31.7% (QoQ. CNBC-TV18 poll saw the OPMs at 28.3%. They plan to add 26,000 employees in FY08

The company said that the Q1 blended pricing is up 1% and the volumes were up 6.9% (QoQ). The company added that they had forex hedges of $ 925 million in Q1. US operations contributed 62.6% of revenues, Europe 26.8%.

Q1 Highlights
* Added 35 new clients vs 34 new clients in Q4
* Added 3730 employees vs 2809 employees in Q4
* Other income of Rs 253 cr vs other income of Rs 119 cr in Q4
* Infosys BPO Q1 Revenues at Rs 200 cr & net profit of Rs 36 cr
* Onsite price up 1.41%; offshore up by 1.05%
* Forex gains of $ 18 mln
* Onsite Revenues at 49.7% of total
* Onsite billing rates up 1.4%, Offshore up 1.05%
* Revenue from top clients grew by 1.2% (QoQ)
* Revenue from top 10 clients declined 3.26%
* Employee utilisation incl trainees at 70.5%
* Employee utilisation incl trainees up 260 bps to 70.5%
* June-end cash reserves at $ 1.6 bln
* Attrition rate at 13.7%

Vertical growth (QoQ)
* Banking : -1.66%
* Insurance: -5.38%
* Manufacturing: 5.45%
* Telecom: 0.48%
*Transportation: 27.81%

“The sharp appreciation of the rupee against all major currencies impacted our operating margins during the quarter,” said V. Balakrishnan, Chief Financial Officer. “However, our robust and flexible operating and financial model enabled us to maintain our net margins while absorbing the impact of appreciating currency, higher wages and visa costs. Liquidity has been further strengthened with cash and cash equivalents reaching US$ 1.6 billion.”

Infosys management said due to Rupee rise impacted revenues to the extent of Rs 287 crore. Growth in North America has been at 7.5% while in Europe it has been at 8.5%. The Rupee appreciation impact was on EPS as well as on margins. We absorbed 7% cost increases and margins were impacted by only 3.5%. Visa cost was up 1% while wages were up 2.5%. Volume growth of 6.9% witnessed in Q1.

OPMs could be impacted by 100-200 bps in FY08. The company has factored in Rs 40.58 on the exchange rate. They are seeing 9.3% growth in non top-10 clients. 26000 employees will be added in FY08. The company has added 10 $ 1 million clients in Q1.

The offshore wages were up 12-15% and onsite was up 5-6%. Almost 73% of the company's revenues come in Dollar terms, 13% in Pound and 5% in Euro terms.

All round growth is seen in all geographies. We are seeing 3-4% improvement in billing in new contracts. We mitigated 4.5% from 7.3% hit on the margin. We have $ 4 billion target in FY08 for revenues. Pricing has been stable with an upward bias. Utilization increased by 1.5% for Q1, the compan says. There will be no price rise assumed in guidance. BPO business could be significantly impacted by Rupee rally. Consulting grew by 22% which forms 4.9% of revenue. Subprime exposure is less than 1%.

Infosys said that the company is comfortable with high of 70% and low of 80% utilisation. Meanwhile the Infosys management declined to comment on Capgemini acquisition. The company is actively looking at US, Europe for inorganic growth.

The company is hedging for short-term to cover 2 quarters. Company has hedged $ 925 million as of June end agianst $ 470 million QoQ. The Rupee is likely to move between 39-41/ $ in the short-term.

Margins from BPO business are down from 21-22% to 16-17%. Tax sops for BPOs should be continued for next 5 years. Price of renegotiated financial deals seen 1.5 % higher.

Satyam an outperformer; target of Rs 542

Event

Using our proprietary margin analysis framework, we conclude that for FY08, there will be an EBITDA margin erosion of 261bps for Satyam. However, we believe Satyam is a good candidate to cross the tier-1 valuation chasm based on strong revenue growth, its converging ROE with Infosys and focus on high-growth engineering services business. We maintain our long-term Outperform rating on the stock, but cut our FY08 EPS forecast by 7%.

Impact

In our proprietary margin analysis, we quantified the effect of ‘sorrow’ factors like a stronger rupee regime (Macquarie’s forecast for FY08 is Rs 40.3 per USD) and wage inflation, and ‘joy’ factors like pricing power and various productivity gain levers. Satyam has USD 650 million of hedging on its books. Based on the 58% natural hedge available to the company and our economics team’s exchange rate forecasts, our calculations suggest that the realised Re rate for Satyam in FY3/08 will be Rs 42.5 per USD. Re appreciation will shave of 248bps from Satyam’s EBITDA margin in FY3/08. Rising wages will dent this by a further 466bps. We have assumed a 15% rise in offshore wages and a 4% increase in onsite wages. The above negatives will be partially offset by levers like better pricing power (163bps), productivity gains (75bps), improvement in the offshore-onsite mix (19bps), an increase in utilisation (22bps) and SG&A leverage (173bps).

Earnings revision

Because of adverse exchange rate movement, we have cut our FY3/08E EPS from Rs 25.8 to Rs 24.0 and our FY3/09E EPS from Rs 31.7 to Rs 30.9.

Price catalyst

12-month price target: Rs 542.00 based on a PER methodology. Catalyst: Large deal wins (>USD 50 million) or an acquisition to penetrate Europe/Japan or building product capabilities.

Action and recommendation

We have cut our earnings forecasts marginally as well as our price target. We maintain our Outperform rating on the stock, with 16% upside from the current level. In the short term, there could be some weakness as Satyam may cut its guidance for FY3/08. However, for long-term investors, it remains an attractive pick in our view.



Neutral on Wipro

Event

Using our proprietary margin analysis framework, we have quantified the effect of ‘sorrow’ factors such as a stronger Rupee regime (Macquarie forecast for FY08 is at Rs 40.3 per USD), wage inflation and ‘joy’ factors such as pricing power and various productivity gain levers. We conclude that for FY08, there will be an EBITDA margin erosion of 388bp for Wipro. This large impact (relative to its peers) is due to its weak hedging position (2 months of net forex inflows compared with the 4 months for Infosys and 7 months for Satyam); coupled with absence of software business and limited pricing power. We downgrade the stock to Neutral from Outperform and cut our FY08 EPS forecasts by 20.3%.

Impact

Wipro has the least amount (USD 600 million) of hedge available among the Tier-1 IT companies. This is sufficient to protect margins only till June 2007. For the full FY3/08, the average realised USD/Rs exchange rate works out to Rs41.1. The rupee appreciation should reduce the EBITDA margin in FY3/08 by 467bp, which is the highest compared with its peers. Rising employee cost, both onsite (4%) and offshore (15%), will result in further decrease in EBITDA margins by 443bp in FY3/08. Coming to some rescue of the EBITDA margin are the levers such as higher price realisation (111bp), productivity gains (78bp), further offshore movement of work (19bp), increase in utilisation (13bp) and SG&A leverage (300bp). We note that Wipro’s margin protection levers are small primarily due to a weaker pricing power and absence of software products business.

Earnings revision

Owing to the negative exchange rate movement, we reduce our EPS estimates for FY3/08 and FY3/09 from Rs 25.2 and Rs 31.1 to Rs 19.8 and Rs 23.4, respectively.

Price catalyst

12-month price target: Rs 499 based on a PER methodology.

Catalyst: Initiatives in the products space or winning large deals (>USD 100 million) or acquisition to penetrate Europe/Japan.

Action and recommendation

We have cut our earnings forecast and revised our price target from Rs 673 to Rs 499. We downgrade Wipro to Neutral from Outperform, and we expect a negative surprise in the 1Q FY3/08 results. There are news reports that the company is looking at a major acquisition in Germany to expand its business in Europe’s largest economy. This may pose an upside risk to our recommendation.



TCS an outperformer; target Rs 1399

Event

Using our proprietary margin analysis framework, we conclude that for FY08 there will be an EBITDA margin erosion of 261bps for Tata Consultancy Services (TCS). However, we believe TCS can adjust to the new paradigm thanks to diversification of its delivery base in near-shore locations like Latin America and Eastern Europe, initiatives in the products business, and inorganic growth potential. We maintain our Outperform rating on the stock, but cut our FY08 EPS forecast by 13%.

Impact

Our proprietary margin analysis quantified the effect of ‘sorrow’ factors like a stronger rupee regime (Macquarie: FY08E Rs 40.3 per USD) and wage inflation, and ‘joy’ factors like pricing power and various productivity gain levers. WTCS started the current financial year with USD 1.1billion of currency forwards and options. This, coupled with 42% of natural hedging provided by its foreign exchange expenses and investments, is enough to shield margins until July 2007. Our calculations suggest that the realised foreign exchange rate for TCS will be Rs 41.4 per USD in FY3/08. The adverse impact of Re appreciation will result in a lowering of its EBITDA margin by 351bps in FY3/08. An increase in onsite wages (4%) and offshore wages (15%) will have a further negative impact of 399bps. The good news is the positive impact of levers like pricing (122bps), productivity gains (88bps), further offshore movement of work (17bps), an increase in utilisation (18bps) and SG&A leverage (244bps).

Earnings revision

Primarily due to the adverse exchange rate movement, our FY3/08E and FY3/09E EPS have been cut from Rs 54.7and Rs 73.1, to Rs 47.8 and Rs 62.9, respectively.

Price catalyst

12-month price target: Rs 1399 based on a PER methodology.

Catalyst: US listing or an acquisition to penetrate Europe/Japan, or some large deal wins (>USD 100 million).

Action and recommendation

We have cut our earnings forecasts and revised our price target from Rs 1654 to Rs 1399. We maintain our Outperform rating on the stock, with 22% upside from the current level. In the short term, there could be some weakness as TCS may guide for slow EPS growth for FY3/08. However, for long-term investors, the stock remains attractive in our view.



Infosys an outperformer; target of Rs 2437

Event

Using our proprietary margin analysis framework, we conclude that for FY08 there will be an EBITDA margin erosion of 210 bps for Infosys. However, we believe Infosys can adjust to the new paradigm thanks to its pricing power, initiatives in the products business and inorganic growth potential. Despite cutting our FY08 EPS forecast by 8.1%, we maintain our Outperform rating on the stock.

Impact

In our proprietary margin analysis, we quantified the effect of ‘sorrow’ factors like a stronger rupee regime (Macquarie’s forecast for FY08 is Rs 40.3/USD) and wage inflation, and ‘joy’ factors like pricing power and various productivity gain levers. Infosys has USD 1billion of hedging on its books. Based on the natural hedge available to the company and our economics team’s exchange rate forecasts, our calculations suggest that the realised Re rate for Infosys in FY3/08 will be Rs 41.6 per USD. Rupee appreciation will shave off 335bps from the EBITDA margin in FY3/08. Meanwhile, rising wages will dent this by a further 377bps. We have assumed a 15% rise in offshore wages and 4% increase in onsite wages. The above negatives will be partially offset by levers like pricing (147bps), productivity gains (77bps), further offshore movement of work (25bps), an increase in utilisation (37bps) and SG&A leverage (217bps).

Earnings revision

Because of adverse exchange rate movement, our FY3/08E EPS has been cut from Rs 83.7 to Rs 76.9, and our FY3/09E EPS been lowered from Rs 113.4 to Rs 103.9.

Price catalyst

12-month price target: Rs 2,437.00 based on a DCF methodology. Catalyst: Winning a couple of greater than USD 100 million deals or acquisition around Europe/Japan penetration.

Action and recommendation

We have cut our earnings forecasts marginally and revised our price target from Rs 2,671 to Rs 2,437. We maintain our Outperform rating on the stock, with 25% upside from the current level. In the short term, there could be some share price weakness as Infosys may cut its guidance for FY3/08 when announcing 1Q FY3/08 results in the second week of July. However, for long-term investors, it remains an attractive pick in our view.

Merrill Lynch Infosys Technologies 16 April


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