Infosys announced its Q4 results on the 13th of April 2017. The expectations were quite muted in the street both on the top-line growth and profit margins. Over the last few quarters, Vishal Sikka and his team have constantly warned the street about the pressure on margins and the likelihood of tepid growth in sales. That is largely a function of weak tech spending among US companies. Additionally, recent announcements on the H1-B visa front by the Trump administration have also soured the pitch for the Indian IT companies. It is in this background that Infosys announced its fourth quarter results.
How did the revenues and the profits pan out at Infosys?
Revenues for the fourth quarter at Rs.17,120 crore was marginally lower. However, net profits fell by 2.8% to Rs.3603 crore. This is almost 4% lower than the consensus analyst estimate for Q4 profits. The bigger worry for Infosys is on the operating front. The EBIT (Earnings before interest and taxes) fell 2.8%. Markets are also likely to be unhappy with the fall in EBIT margins from 25.1% to 24.6% as this 50 bps fall hints at clear pricing pressure. Overall, the numbers have been weaker purely for operating reasons. While the global IT industry has been moving increasingly towards digitization, Infosys is yet to keep in step. Additionally, the IT outsourcing business is increasingly getting commoditized (as Vishal Sikka as himself admitted) and that means that very soon the company will have to look at substantial automation and displacement of manpower if it wants to stay competitive in the industry.
Guidance is conservative; in fact even a little cautious…
The Infosys management has guided revenue growth (in constant currency terms) in the range of 6.5% to 8.5%. However, considering the current negative headwinds in the global IT spending, the company could end up growing at the lower end of the range. This is also lower than the consensus estimates of growth which was pegged in the range of 7.5% to 9.5%. The lower guidance could be attributed to the more stringent H1-B visa regime that is likely to come about. This conservatism is also understandable considering the experience of the previous year. In the last year, the company had guided for double-digit growth in sales and had consistently revised its guidance downward leading to substantial value erosion in the stock.
Changes in the capital allocation policy…
One of the key highlights of the result announcement was the paradigm shift in the capital allocation policy of the company. Traditionally, the company has been conservative with respect to the quantum of dividend payout as well as with respect to corporate actions like buyback of shares. The company has announced a shift in both these variables. On the dividends front, the company used to maintain a policy of paying out up to 50% of its post-tax profits to its shareholders. Under the new policy, the company will pay up to 70% of its free cash flows as dividends. This shift is likely to make Infosys more desirable from a dividend yield point of view. The company has also promised to return $ 2 billion (approx Rs.13,000 crore), either in the form of dividends or via buyback during the year. While the actual buyback has not been announced, this announcement certainly opens up the possibility that Infosys will also reward shareholders through buybacks like the other IT majors in India have done recently.
Key pointers from the Infosys results; going ahead…
• The growth and margins are clearly under pressure and is likely to be the case across the board. Of course, companies like TCS may be less vulnerable to these risks due to their 18% exposure to the digital space.
• The stock is currently valued at around 14 times its trailing earnings and around 13 times its one-year forward earnings. At these levels, Infosys is available at the lowest P/E ratio since it started announcing quarterly results. However, attractiveness may be more a function of growth guidance and margin visibility rather than purely the P/E ratio.
• The capital allocation decision could be a double-edged sword. Normally, investors and analysts do like dividends but such companies rarely get rich valuations. A more liberal dividend payout policy will be interpreted by the market as a signal that growth opportunities are hard to come by. This could put pressure on the overall valuations of Infosys going ahead.
• On the subject of buybacks, it needs to be remembered that buybacks have rarely created value over the long run. According to empirical studies, when a company does a buyback, the EPS of the company goes up due to lesser number of shares outstanding. However, the P/E also comes down due to assumptions of tepid growth prospects. Hence the overall impact on market value is minimal; and at times even negative.
• Lastly, the differences of opinion between the promoter group and the current management do not give the institutional shareholders too much comfort. In the larger interest of the shareholders and the valuation of the stock, these issues must be closed out at the earliest. This is essential from an institutional shareholder point of view.
It is not just Infosys, but the entire tech sector is going through challenging times. The industry needs to reinvent itself and the markets are looking up to Infosys to take the lead and show the way back to growth. After all, Infosys has been the bellwether in the Indian technology sector in the true sense of the term.
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