Expectations met

Improved billing rates and growth in core IT services helped Infosys grow

Infosys' results for the September quarter were impressive with both revenues and operating profit growing in double digits. Nonetheless, they were largely in line with expectations - most analysts had predicted that Infy's growth would be in double-digits.

In fact, to achieve consensus estimates of an EPS of Rs 92 in FY06, Infy had to grow earnings by over 10 per cent not only in the September quarter, but also in the December and March quarters.

The way the markets reacted to the results, however, gives the impression that Infy's results were a big positive surprise. The stock hit an all-time high of Rs 2,730 on Tuesday before settling at Rs 2,683, about 2.3 per cent higher compared with Monday's close. Infy now trades at 34 times trailing earnings and 29 times consensus estimates for FY06.

One of the reasons IT stocks have done well in the recent past is because the rupee has depreciated considerably since the beginning of the year. The rupee is currently about 3.5 per cent lower than that at the beginning of the financial year.

A lower value for the rupee benefits software exporters such s Infy, but a look at the company's September quarter numbers show that there's no significant impact on margins yet.

Operating margins were flat last quarter, despite double-digit volume growth, marginally higher pricing and a favourable rupee. To be fair to Infy, gross margins did increase by 50 basis points, and it was actually a provision for bad and doubtful debts that shaved off most of these gains at operating profit level.

However, given that the average billing rates improved, both offshore and onsite, and volumes grew in double digits in both segments for the core IT services business, margins could have been higher. The depreciation in the rupee did show up in other income, though, which jumped 54 per cent sequentially.

In fact, higher other income and lower tax provisioning buoyed EPS growth to 13.4 per cent on a quarter-on-quarter basis. At the operating PBT level, growth was lower at 9.3 per cent. Even on a year-on-year basis, EPS growth (33 per cent) was higher than the growth in operating PBT (27.6 per cent).

It makes more sense to look at growth at the operating PBT level, since EPS growth could fluctuate more because of changes in other income and tax provisioning. Last quarter, for instance, there was a tax write-back of Rs 20 crore, which impacted net margins by nearly 100 basis points.

For the six months ended September 2005, Infy's operating PBT grew 30.4 per cent, while EPS growth was higher at 34 per cent thanks to a jump in other income and a lower tax provisioning thanks to the tax write-back.

The fact that Infy's trailing PE exceeds growth in operating PBT (thus far this year) is matter of concern, as far as valuations go. True, the company is confident that demand should continue to be strong in the near future, but the September quarter results don't provide any major reason for the revision of analysts' earnings estimates.

Current consensus estimates requires Infy to grow earnings by nearly 10 per cent for the next two quarters as well. The markets' enthusiasm about the results, therefore, seems overdone.

Essel Propack

Essel Propack's announcement of a buyback at Rs 390 helped the stock gain about 3 per cent on Tuesday, but the current price of Rs 371 is still about 4.9 per cent lower than the company's offer price. The buyback aggregates Rs 57.5 crore or about 4.7 per cent of the company's share capital.

The promoters already hold around 37 per cent of the firm's equity as at the end of the June quarter. The company's consolidated internal accruals (cash flow or profits + depreciation) amounted to approximately Rs 77.1 crore in H1 CY05.

Essel has been attempting to build a niche in the fragmented global laminated tubes market via acquisitions. The most recent takeover as part of this strategy was of the UK-based Telcon Packaging.

The acquisition has helped the company emerge as one of the largest global suppliers of laminated tubes, with close to a 33 per cent share of the 12 billion global tubes market.

However, Essel 's market share of the estimated 2.5 billion annual European laminated tubes market was estimated at only 10 per cent and this acquisition is expected to help it ramp up market share in this market.

The company like other end users of polymer products has had to grapple with higher input costs "" higher prices of petrochemical intermediates lead to an almost 160 basis points increase in the ratio of raw material to net sales to 44.5 per cent in the June quarter.

As a result, consolidated EBITDA margins declined almost 400 basis points to 24.8 per cent in the June quarter. Analysts said the company is expected to hike prices shortly to minimise the impact of higher input costs.

The company is buying its stock at about 13 times estimated consolidated earnings for CY05 of Rs 29. Given that the company's growth prospects are good, investors may want to hold on to the stock, since it could be a good long-term investment.