$500 mn deal with Google pulls Infosys in focus; analysts see 35% upside

A $500 million deal with search-engine giant Google has once again brought the limelight back on Infosys, strengthening the belief that large deal momentum continues to be strong for this Indian IT bellwether, which could translate into a windfall for its shareholders.

A report in the Economic Times stated that Infosys has won a $500 million deal from Google to provide customer experience and engineering support for its product. Following the development, the stock was trading up by 0.61 per cent at Rs 1,351.70 on the NSE on Thursday.

The stock, however, has lagged benchmark Nifty on a year-to-date basis as it added 7 per cent against a 9 per cent rise in the Nifty50. The underperformance could soon come to an end, believe analysts, who eye an up to 35 per cent upside in the stock from current levels.

What could drive this rally?

Robust Deal Wins

Varun Ahuja and Krati Sankhlecha, research analysts at Credit Suisse, note that the deal with Google has strengthened the company's positioning in the technology vertical which has been one of the fastest-growing segments for the company over the past 12-24 months.

So far, in FY2021, Infosys has bagged deals worth $12 billion as against $9 billion in FY20. Out of the deals signed in the nine months to FY21, net new large deals stood at $8 billion.

"We believe the pace of deal signings would remain strong in the coming quarters, as it has been reaping benefits from accelerated investments on enhancing capabilities, sales transformation initiatives, and increased focus on large deals over the past three years," say analysts at Sharekhan in a note.                                  

                                              

Higher Spending on Cloud Tech

Covid-19 acted as a trigger in accelerating the demand for digital and cloud transformation across industries in CY2020. The company’s digital revenue has reported a 7.6 per cent CQGR since Q1FY2018, and its contribution stood at 50.1 per cent in Q3FY2021.

The management now expects higher spending on Cloud-related technologies by clients to drive the growth in FY2022E. And to tap into this opportunity, the company had launched Infosys Cobalt in August 2020.

"Cloud is the single biggest growth driver in the tech sector. Despite being popular for decades, total public cloud spending in 2020 was $258 billion, less than 20 per cent of total enterprise tech spending of about $1.5 trillion, offering ample room for growth," says Vikas Ahuja, research analyst at Antique Broking, in a note co-authored by Ashish Agrawal.

Investment Strategy

Even after a 164 per cent rally since its 52-week lows hit in March 2020, the Salil Parekh-led firm remains Credit Suisse top pick in the IT space.

"The stock is currently trading at 25.5 times 12M forward PE. Its discount to TCS is still high at 12.8 per cent, while the earning growth difference has shrunk to -0.9 per cent. We have an Outperform rating on the stock as we expect Infosys’ valuation discount to TCS to narrow in the coming months as investors draw comfort on the sustainability of the company’s performance," it said. Credit Suisse has a target of Rs 1,810 on Infosys.

Sharekhan analysts share the views. "At the CMP, the stock is trading at 26x/23x its FY2022E/FY2023E EPS, at a nearly 11 per cent discount to TCS. We expect Infosys’ valuation gap with TCS to reduce further, given the anticipated outperformance in revenue growth with stable margin performance."

It maintained Buy rating on the stock with a target of Rs 1,650.

Sector outlook

The constant flow of large deals has reinforced analysts’ view that the sector has entered a technological up cycle. Analysts at Credit Suisse expect the sector revenue growth to remain in low-double digits even beyond FY22 given the strong demand for digital technologies.

That said, bloated valuation multiples, which are higher than global tech in many cases, worries analysts.

"We see spreads to be at a bigger risk of widening for IT (compared with the market) as unrealistic long-term growth expectations correct, besides the systemic risk of rising low rates. In the near-term, a reflationary environment should make the sector’s relatively low growth unenticing," observes a report by ICICI Securities.