Infy: Guidance dampener

Infy results are likely to impact IT stocks adversely

All eyes were on Infy's guidance for FY06, and the company's announcement that it expects its FY06 EPS to grow between 23 and 25 per cent isn't really exciting.

Especially since consensus estimates were of a 36 per cent growth in earnings. Even after accounting for the fact that Infy is generally conservative, the guidance given was lower than expected.

Worse still, earnings for the quarter ended March 2005 were also lower than expected. Earnings before exceptionals grew just 3.3 per cent sequentially, on a revenue growth of 6 per cent. Importantly, volume growth fell to just 6 per cent, after three quarters of double-digit volume growth.

According to the company, volume growth slowed because some of its clients were going through a reorganisation in senior management, which resulted in a slowdown in decision making at these companies.

Further, some its clients in the financial services space (which accounts for around 35 per cent of revenues) were preoccupied with compliance issues relating to the Sarbanes Oxley Act, the Anti Money Laundering Act and the Patriot Act.

The impact of these two factors is expected to spill over in the June quarter, which explains the muted guidance for this quarter. The company expects revenues and earnings to grow by around 1.5 per cent at best.

While Infy's conservatism seems justified this time around, the fact that growth rates would fall in two consecutive quarters was the last thing the markets were expecting.

This should lead to a correction in Infy's share price, which now trades at a trailing PE of 30.5 times, higher than the EPS growth of 25 per cent projected by the company.

Also, since Infy has been impacted because of compliance issues facing its clients, it is expected that most other IT players will also be hit. This could mean a hit on the share prices of most IT stocks.

Coming back to Infy's results, it's important to note that there was an increase in average billing rates for both onsite and offshore services, by 1.3 and 0.9 per cent respectively. Despite this and the fact that the rupee had no major impact last quarter, operating margin improved by just 60 basis points.

Another worry is the way Infy's free cash flow has been decreasing in the past year. For the whole year, its free cash (operating cash flow - capex) has declined by over 52 per cent to Rs 540.6 crore. But this was partly because one of its clients postponed a large payment (amounting to 12 days' sales) to April this year.

But even after adjusting for this, free cash flow has declined by over 30 per cent, thanks to a 95 per cent jump in capex and an increase in working capital. According to the company, capex would be higher even this fiscal.

The positive factor about Infy's guidance is that it expects revenues and earnings to grow at an average of 7.5 per cent on a sequential basis in the next three quarters.

This is also supported by aggressive hiring plans of about 9600 employees for its IT services business in FY06. For now, though, the drop in performance last quarter and the muted guidance for the June quarter is expected to weigh down the stock.

ABB India

The first quarterly result in the capital goods sector has been better than expected. The facts about the upturn in the capex cycle are well-known, but the concern was that higher input costs, principally on account of rising steel prices, could act as a dampener.

ABB's March quarter results show that net profit has expanded 62.72 per cent to Rs 27.5 crore. Steel prices in the last quarter were about 8 per cent higher on a y-o-y basis. As anticipated, higher input costs like steel and copper have led to the company's material costs rising 37.24 per cent to Rs 466.9 crore.

In spite of that, however, as a percentage of net sales, material costs have contracted 25 basis points to 76.84 per cent. The company's management has pointed out that they have included an escalation clause in contracts recently signed, in a bid to manage rising input costs.

It is these cost management steps, rather than the well-known capex upturn, that have strengthened investor appetite and enabled this stock to outperform the broader market, over the past one month "" this stock has risen 1.6 per cent vis-a-vis a 5 per cent decline in the Sensex.

Meanwhile, helped by a 50.75 per cent growth in the order inflow for the March quarter, the company's outstanding order book has expanded 35.76 per cent to Rs 1,583.8 crore.

A larger turnover has helped operating profit grow 57.24 per cent to Rs 37.1 crore in the last quarter and operating profit margins have expanded 76 basis points to 6.11 per cent.

Going forward, the UPA government's emphasis on expanding the electricity network, especially in rural areas, would be the key growth driver for ABB India. To leverage the better operating environment, the company is planning to invest approximately Rs 200 crore this year in expanding its capacities.

With contributions from Mobis Philipose and Amriteshwar Mathur