Infosys: Weak numbers

Infosys results are far worse than what the market expected

Given the euphoria surrounding large cap IT stocks, there was ample room for disappointment from Infosys' results announcement. And although Infy did better than the guidance it gave at the end of last quarter, its stock price fell by over 4 per cent after its results were announced.

While the major disappointment for the markets was that the company barely increased its guidance for the whole year, even the results were far from exciting.

Infy raised its earnings guidance by just 10 paise to Rs 84.7-Rs 86 a share, but since consensus estimates are almost 10 per cent higher at Rs 94 a share, the slight change was far from what the markets were looking for.

June quarter revenues grew just 4.2 per cent sequentially, slightly better than the 1-2 per cent growth guidance given by the company. In the core IT services business, revenues grew just 2.3 per cent in dollar terms, on the back of a meagre 2.6 per cent growth in volumes.

The fact that average price realisations fell last quarter was a negative surprise, since the company has been talking of an upward bias for quite some time (especially for new clients) and also because there has been no adverse change in service mix.

While the company has blamed the salary hikes and higher visa application fees for the drop in margins, it appears that pricing pressure also had a part to play. First, the drop in operating margin is much worse than the reported figure of 150 basis points.

The March quarter had a high outgo on unusual expenses like provisions for doubtful debts, loans and advances and provision for post-sales client support and warranties "" together, they amounted to Rs 24.4 crore. Last quarter, these expenses amounted to just Rs 1.64 crore. Adjusted for this, the fall in operating margin would be as high as 265 basis points.

Also, product revenues increased by almost Rs 30 crore, most of which was through license fees which flows straight to the bottom line. If one were to adjust for this, the drop in margin would be in the region of 350 basis points.

Another problem the Indian IT major is facing is attrition. On an annualised basis, the June quarter attrition was 16.1 per cent compared to 11.2 per cent in the March quarter.

Although the management has vehemently denied any adverse impact of the large scale plans of MNCs such as Accenture and IBM, it looks like their huge manpower requirements are affecting Indian companies.

Further, the company has warned that mega development/maintenance deals may not be profitable in the first year of operation, which goes against market expectations that such deals would help the company easily beat its guidance for the year.

As a result, analysts would not only have to relook at their aggressive estimates for this fiscal, but also those for FY07. True, the performance in one quarter does not necessarily indicate the trend going forward, but the June quarter results give strong signs of pricing and margin pressure, apart from trouble on the attrition front.

While Infy's stock price fell on Tuesday, the correction doesn't seem enough given that it still trades at 26 times FY06 earnings estimated by the company.

MphasiS

Although MphasiS's results weren't as disappointing as Infy's, they weren't too exciting either. IT services revenues grew by 13.1 per cent sequentially, but that was mainly because of its acquisitions, Princeton Consulting and El Dorado. Adjusted for their incremental contribution, growth would be lower at about 5 per cent.

Worse still, the BPO business fell by 3.3 per cent sequentially, because of the twin impact of a price reduction given to clients and slower ramp ups.

Since the BPO business used to be the company's growth driver, the drop in performance is reason for concern, although the MphasiS management believes that growth in IT services will be robust.

Further, cost of revenues also increased by 12.1 per cent sequentially for IT services, mainly because of salary increases which have been given effect from April 1.

Cost of revenues rose by 2.8 per cent for BPO services, the cost being lower owing to a reduction in the number of employees and lower telecom charges.

With profitability taking a hit, MphasiS' gross margin fell by nearly 100 basis points. Thanks to savings on selling, general and administration expenses, the drop in operating margin was contained to 44 basis points.

The company's stock price, however, continues to be driven by non-fundamental factors, given the strong likelihood of a change in ownership in the near term.

The stock, which has been re-rated as a result, is expected to remain at these levels because of hopes of a higher open offer price.

With contributions from Mobis Philipose and Amriteshwar Mathur