Board vs founder war: Is Infosys stock a good contrarian pick?

Infosys stock fell 9.6% last Friday after Vishal Sikka resigned as its CEO

Infosys stock fell 9.6% last Friday consequent to the announcement of resignation of its CEO, Vishal Sikka. Subsequently on Saturday, as proposed earlier, the company announced buyback of 11.3 crore number of shares from investors at a price of Rs 1,150 per share for total value up to Rs 13,000 crore through a tender offer on a proportionate basis. This is 4.92% of total paid up capital and at a premium of 24.5% on Friday’s closing price.

We maintain our view that the wealth creation opportunity in the large IT stocks is not there at least for the next 3 years. Slowdown in the global economy and the base effect of the IT exports would make it difficult for the IT exports to grow in strong double-digits in the near future. However, we believe that the reaction to the stock on Friday was largely because of fear factor and it does not deserve such punishment:

Infosys has emerged as an institution over the last 3 decades: With an annual turnover of around Rs.68,000 crore, a net profit of around Rs 14,000 crore and an employee base of around two lakh, it can easily attract a suitable talent. 

In our view, a company, which spends over Rs 37,000 crore per annum towards “Employee Benefit Expenses” would not find it difficult to attract the suitable talent. As per the latest media reports, Infosys has already started look out for the CEO; 

It is a cash-rich company: Even after this buyback program, Infosys still would have a cash of around Rs 26,000 crore as the cash reserves at the end of June 2017 was Rs.39,335 crore. At the end of the first quarter of FY2018, the cash generated from operating cash flow was Rs.3,598 crore. The operating cash flow as percentage of net profit remained over 100% for the 4th quarter in a row. The yield on cash for the quarter was 7.07%. 

Theoretically speaking, Infosys can do a buyback of about 5% of its paid up capital almost every year as it is expected to generate an annual profit of around Rs 14,000 crore at least for the next 2 to 3 years (i.e. till the fortunes of the IT industry dramatically changes). The same would be EPS accretive – even if its net profits grow in poor single digit, its EPS can grow quite significantly due to buyback plan. In case, it doesn’t repeat buyback of shares regularly, then its dividend payout can go up quite consistently and the dividend yield can improve close to 4% in the next 3 years on the current market price;

In our view, the stock has been already punished more than what it deserves – the stock is down 14.5% from its 52-week high (October 2015). In the same period, the Sensex has gone up 14%. The stock has already witnessed a severe under-performance. The stock trades at 14.7 x FY2017 earnings. This valuation is at a steep discount to peers like TCS and it is on par with small IT companies which have an annual revenue of less than Rs.5,000 crore!

Going forward, with reduction in the paid up capital, even a marginal growth of around 3% in its net profit in the next 2 years can take its EPS to around Rs 70 in FY19. The same would value this company, on current market price, at 13.2x FY2019E EPS, which is very attractive for this cash-rich institution. 

In case the management decides to do another buyback (which is a better option than dividend payouts due to tax benefits) within next two years – to reward its shareholders, who have lost the great opportunity to create wealth in this bull market – the EPS can go up significantly in the future beyond this estimate. 

We also expect the rupee to weaken slightly in the short-term due to international political factors, FIIs turning net seller of Indian bonds in the last 3 weeks and absence of their major buying into Indian equities, and slowdown in the Indian industrial economy. The same would augur well for the IT companies like Infosys. Considering these facts, we continue to recommend a BUY on the stock with revised target price of Rs1,100 which is 15.7xFY2019E EPS.

The author is the Founder and Managing Director of Equinomics Research and Advisory

Disclosure: I, G.Chokkalingam and Equinomics / Associate Company do not hold shares of Infosys. However, Equinomics has received the advisory fee for rendering investment advisory services to one of the investment companies of one of the promoters of Infosys