Exercising caution

SMARTSHARE

The market has a short memory. When Infosys announced the full-year 2004-05 results in April, it also issued a clear warning that Q1 (April-June 2005) would see a slow-down in revenue growth because of special circumstances in the key US market.

US customers were concentrating on complying with a new regime of fiscal regulation and that would hobble IT spending. So, lacklustre Q1 results should not have been a surprise for anyone.

Actually Infy did better in the Q1 than it had suggested in its own guidance. But the market conditions seem to have got worse than the company had forecast in April. Its full-year 2005-06 guidance suggested that the revenue numbers would be flatter than analysts had hoped. As a result, the stock price fell by 4 per cent after the results were announced.

Ironically, Infosys has also suffered from its conservatism and its excellent track record. Analysts have noted that it consistently beats its own guidance.

The company raised its EPS estimate by 10 paise to a band of Rs 84.7-86 a share, but the market's consensus estimates were at Rs 94 a share so, naturally there was disappointment all round.

Infy also warned that its new development/ maintenance deals will only start adding to the bottomline in 2006-07, thereby causing more disappointment to the market.

In terms of Q1 2004-05 versus Q1 2005-06, revenues grew 37 per cent. But in sequential terms, which is what the short-term investor tracks, the April-June quarterly revenues grew 4.2 per cent sequentially over January-March 2005, just marginally better than the 1-2 per cent growth guidance offered in April.

IT services revenues grew just 2 per cent sequentially in dollar terms, on the back of a 2.5 per cent volume growth in volumes. Average price realisations dropped last quarter "" this was a sign of tighter conditions and a genuine surprise given that IT companies have been gung-ho about holding the priceline over the past year.

Operating margins dropped "" apart from pricing pressure, salary hikes and higher visa fees caused higher expenses.

Officially, there was a sequential 1.5 per cent drop in OPM. In reality, January-March 2005 had unusual expenses to the tune of Rs 24 crore in provisioning for bad debts, post-sales client support, etc.

In April-June, such unusual expenses dropped to only Rs 1.6 crore. Adjusting for that differential, the OPM in April-June must have dropped quite a bit more in sequential terms.

Summing up, the Q1 results showed pricing and margin pressure as well as a slowdown in top-line growth rates. Even post-correction, the stock is still trading at 26-28 times estimated FY 2005-06 earnings. That's a little too close to the 1 PEG level for the comfort of a long-term investor.

In specifics, the Q2 guidances are in the band of Rs 2,200-2,215 crore in revenues, and FY 2005-06 revenues are expected to be in the range of Rs 8,947-9,050 crore "" this is a marginal upwards revision of earlier guidance of Rs 8,890 crore to Rs 9,030 crore.

Fluctuations in the euro and dollar could scramble those estimates. So could further terrorist strikes so Infy has reason to be conservative in its forward statements. Things aren't likely to look up in the 2005-06 fiscal.