What has upset UBS about Infosys that others have failed to see?

UBS' report differs from others as it takes a business call on Infosys rather than one based on quarterly numbers and guidance

Nearly a month after Infosys announced its march quarter results, one of the biggest foreign broking houses in the country, UBS has downgraded the stock. While the downgrade to Sell is not uncommon, the fact that the target price has been slashed by nearly 30 per cent is rare. UBS earlier had a price target of Rs 4,050 which has now been slashed to Rs 2,750. Infosys presently trades around the Rs 3,070 range . 

 

What is important to note is that out of the 63 analysts tracking Infosys (as per Bloomberg data) only three have a Sell rating on the company. UBS is now the fourth. Around 75 per cent of the analysts have a Buy recommendation while remaining have a Hold recommendation on the company. UBS is the biggest broking house that is bearish on the stock and one that has the lowest price target. 

 

So what is it that UBS (Indian broking firm Ambit already has Sell rating on the stock) has seen that other broking outfits have not. 

 

UBS has broken down the business of software companies into different verticals and identified areas where growth is expected. The UBS report written by Diviya Nagarajan says that the next wave of growth for large Indian IT vendors will be led by infrastructure services and business process outsourcing (BPO). 

 

Infosys has less than 15 per cent of its revenues coming from these segments as compared to 25-35 per cent for TCS and HCL Tech. Infosys has just started focussing on these segments, but UBS believes that the slow growing application business of Infosys which contributes 85 per cent of the revenue will remain a drag. The company has already indicated through its commentaries that it has trouble jumpstarting growth in its base segment.

 

The other issue is of attrition. Apart from Ambit and now UBS most of the other broking firms have highlighted the attrition problem as a footnote. Ambit (Read here) was the first to say that Infosys was living in denial when they clarified that the loss of senior management officials and overall attrition is not hurting the company. UBS has gone a step further and cited the case study of Wipro and how constant management churn since 2005 has played a major role in decline of Wipro's market share. 

 

To make matters worse for Infosys, TCS has played a smart game by hiking wages by 10 per cent for offshore employees and 2-4 per cent for onsite ones as compared to 6-7 per cent and 1-2 per cent respectively for Infosys. Attrition rate at Infosys is at its all time high with the company losing nearly one-fourth of its FY13 employee base in FY14, says UBS. The wage differential between the two companies and softer revenue outlook by Infosys is expected to further spike attrition in the company. 

 

While most of the other analysts are saying that Infosys will beat its guidance, UBS feels that high attrition level will impact revenue acceleration and limit the company's ability to beat its revenue guidance of 7-9 per cent (which is much lower than the nearly 14 per cent growth projected by Nasscom, the face of the industry) despite improving demand and a currency advantage. 

 

Concerns on Infosys' operations have been raised by other analysts too, but none of them had summed it up and been brave enough to go against the consensus opinion. JP Morgan which has a Overweight rating and a price target of Rs 4,000 on Infosys in its April 23, 2014 report on India IT Services highlighted the leadership role of TCS over its peers, especially Infosys. The report observed that TCS was defining the agenda through its forward commentary in contrast to the commentary of others playing catch-up. While TCS has a longer term plan of entering hardly penetrated markets like Japan and strengthening its presence in digital and SMAC (Social media, Mobile, Analytics and Cloud Computing), Infosys and Wipro are still talking on the need to improve win rates in large deals, in other words, operational issues. 

 

Jefferies in its coverage on Infosys with Buy rating and a lower price target of Rs 3,675 (from its earlier target of Rs 4,170) highlighted the concerns of the company. The report said that Infosys was at a stage where most of its financial metrics are at their worst. Growth has been volatile, margins have fallen by 450 basis points in 13 quarters. Yet the Buy recommendation was based on the reset of expectations for next year, an improvement in growth or margins. The report says that turnaround hopes are hinged on Chairman Murthy. 

 

It is the hope of Murthy working his magic that is preventing most of the analysts to see beyond the quarterly numbers. Where UBS' report differs from others is its business call on Infosys rather than one based on quarterly numbers and guidance. Share price movement of Infosys shows that the market seems to have respected that.