Infosys Technologies Ltd

Faced with a rather difficult macro environment marked by a 11 per cent appreciation in the rupee and a US slowdown, Infosys Technologies has managed healthy growth over the last fiscal. While revenues for the year have grown by 20.1 per cent to Rs 16,692 crore, net profits have expanded by 20.8 per cent to Rs 4,659 crore.

Infosys’ service-mix is changing in favour of high-value services, non-BFSI verticals are growing and headroom is available in tweaking key operational metrics.

Investors may consider buying the stock with a one-year perspective. There may be scope for capital appreciation despite a 16 per cent gain in the stock price in the past week. At Rs 1,666 the stock trades at 17 times its estimated FY09 earnings.

Improving service-mix


Application development and maintenance, a low margin service, remains the main contributor (45.4 per cent) to overall revenues; but has come down by 3 percentage points compared to last fiscal. Services that are of higher value and carrying higher billing rates such as package implementation and consulting have increased their contribution.

The management has indicated that Infosys Consulting (a subsidiary) may break even by next year. Infosys has also taken an ‘asset-light’ approach in the infrastructure management services, focussing on pure-service deals and become hardware independent and neutral. Infosys is betting on its product business as a growth driver and this has grown 11 per cent over the year. A newer version of Finacle has been released to include such new features as Islamic banking, mobile banking and core banking.

This added feature may enable it to penetrate the West Asian market. Since the investment phase is just about completed here, licensing of this product should bring in better margins. Growth in this group is likely to be non-headcount-linked from the current level. Together, these trends could improve realisations for Infosys in the coming year.

Changing mix


Infosys has also reduced dependence on the troubled BFSI vertical by about two percentage points, with telecom, manufacturing, and retail verticals chipping in with bigger shares in the overall pie.

The company already has strong engagements in the telecom space in Europe. With new spectrum award for wireless Internet and mobile services to operators in the US, there is scope for Infosys to extend its presence in this vertical.

With sectors such as automotive and aerospace becoming more software-intensive, the manufacturing vertical of the company also is strengthening, with more client wins. This paves the way for more broad-based growth.

Europe, a market with substantial potential, has enhanced its contribution to revenues from 26.4 to 28.1 per cent, while the contribution from North America has declined to 62 per cent. This reduces the impact from key pressure points on the company.

Launches hold promise:


The company has launched software as a service (SaaS) for social computing and has also managed to win a deal in this space. SaaS is a delivery model where clients pay for IT systems/services on a usage basis.

The company would be responsible only for hosting and maintaining the application platform with minimum requirements at the client’s end. This minimises personnel deployed on the location. This reduces the cost of implementation drastically and may help smaller companies in IT adoption. This service is at a nascent stage. If it does become a success, its scope can be extended to deliver Infosys products also on such a platform.

The launch of learning service and a client win therein has also been achieved. Both these services, especially SaaS, offer higher margin potential, if scaled up.

Operating metrics


Importantly, SG&A (selling, general and administrative) expenses have fallen during the year, indicating effective client mining strategies. This is supported by a 97 per cent repeat business level. The increase in the proportion of fixed-price billing (31 per cent currently, up from 26.7 per cent) contracts has been significant over the past year.

Utilisation at 70 per cent levels offers room for improvement and could aid volume-based growth during turbulent quarters.

Fixed-price contracts require planning in terms of resource allocation and utilisation and definitive timelines. It enables the company to predict cash-flows better, formulate a suitable hedging strategy and improves realisations. This may become even more relevant in the current turbulent times where clients would demand pricing that is linked to defined outcomes and SLAs (Service Level Agreements).

The management guidance of a 19-21 per cent growth in revenues and 17-19 per cent growth in EPS assumes no increases in billing rates; so any price increase achieved may lend an upside to revenues and earnings.

The company also hopes to reduce its onsite component steadily. As these are high-cost revenues, if such projects are migrated offshore, it may enable optimisation of manpower costs.

Macro concerns remain


Infosys, as with other IT stocks, has been dogged by concerns about a slowdown in global IT spends. In this respect, Infosys has indicated that while there is a slowdown in the IT budgets of BFSI clients. 76 per cent of its top 100 clients, with whom a ‘dip-stick’ survey was done, have indicated a flat or lower budget.

The other concerns relate to wage inflation of 11-13 per cent offshore and 4-5 per cent onsite this year. After the expected phase out of the STPI scheme in March 2009, tax incidence (currently at 15 per cent) may move to 20-22 per cent, leading to pressure on earnings growth.