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Infy results are down; market on its highs – Irrational Exuberance?

The Infosys results for Q1 FY08 are out. Not very surprisingly, the guidance for FY08 has been downgraded, and results are a bit disappointing.
Some notes:

  • Revenue and EPS (post one-time tax refund) grew about 25% on the same quarter last year. But on a quarter on quarter basis, profits are down about 5%.
  • Pressure is really from the 7% increase in the rupee value, which has resulted in a rupee loss of about Rs. 287 cr. and 1000 cr. on the whole year. (that’s nearly 1/4th their revenues)
  • Some one time costs this quarter were – visa costs and wage increases. This move affectd about 3.5% of the total margins. There should not be so much margin pressure in the remaining quarters of the financial year.
  • Current EPS guidance for FY08 is about Rs. 79 per share, which is 13% rise from FY07.
  • At 79 EPS, the current price of Rs. 1900 gives us a P/E of 25. For a 13% near term growth, this is not all that great, but it may work out quite well if the rupee stabilises at the Rs. 40 level.
  • They have a currency hedge of about $925 million, which is about one quarter’s revenue. That means if the rupee slides further they are only covered for one quarter. The current guidance is at Rs. 40.58 per dollar, and the dollar is already below that at Rs. 40.4 right now.
  • Employee additions: 7,000 employees gross added, 3400 net. Meaning: 3600 people left the company in a quarter. That is half of the amount they hired! They will hire 26,000 employees (gross) so I would expect that employee strength will actually grow only half that – which is 13,000 people. That’s about 20% of their current strength, and given that their revenues grow with the number of people they have, their revenue growth can’t be much more than 20%.
  • They have a 3-4% increase on the pricing on new contracts compared to existing ones. Considering that new clients have accounted for only 10% of profits, I assume this will impact the profits upwards by only 0.5% or so. Blended pricing overall has increased by 1% – which means if the rupee slides by more than 2% (assuming margin impacts half of the slide) the operating margin is hit hard. 2% impact on the rupee is only 80 paise below Rs. 40.56, which is Rs. 39.76. Below that, Infy gets impacted.

Overall, while the rupee guidance is muted, the dollar guidance is still robust, around 31% Year on Year growth. But we talk in rupees so to give a 25 P/E to a company whose EPS grows at 12% may be a little high. 20 P/E may be more acceptable, and that too considering that if the dollar stabilises, Infy may still be able to manage 20% growth. At 20, the price is about 1600, 300 Rupees lower than today.

But longer term problems still linger. High attrition (half of the hired candidates left this quarter) will hit revenues hard in an industry which is essentially poaching on the small pool of available talent, which grows smaller each day as many of the really good folks start moving out to set up their own entrepreneurial ventures. The ones that are left, are in demand by the Cognizants, Accentures, IBMs and others who will pay them much higher than Infy will, simply because they have leverage Infy does not. Finally, they have to build talent by training them – which they are doing – but training is a time consuming task and as deeply affected by attrition as any other.

The rupee will not stop its upward path; not in the near future. With ECBs, FII funds, FCCBs and NRI transfers increasing every month, there is very little the RBI is likely to do to stem the rise – for any attempt to do so will fuel inflation.

The only way to grow for Infy is inorganically. Acquire, acquire, acquire. With over $1 billion in the kitty, this may be a good time to acquire product companies or SaaS companies in India, or even to buy out captive development units of U.S. companies. But a merger averse company like Infosys is perhaps going to hit just one big fish and work to justify it over the years. That does not make me a happy camper.

Now consider that the market is shrugging off such information and still staying at record highs. The immediate future is not all that exciting: Auto companies are going to be hit hard going by monthly figures. Pharma and IT have a dollar problem. Banks have higher interest receipts, but in the next year, credit growth will slow down if these interest rates continue.

Oil and gas companies have an underlying issue in the form of a much higher oil rate – it’s back to the $70+ a barrel now. Plus, lower auto sales and upcoming elections means the profitability will take a hit.

All this is near-term stuff. Yet, the market is reaching record highs. That simply means a drop is in store, but it may happen only after a sudden, sharp rise. This looks like irrational exuberance – you may want to ride it, but be ready for a sharp decline very soon. Be careful if you are depending on your stock market investments for liquidity later this year.

And if you are a more active investor, keep your stop losses handy. Ride the wave – heck, even invest more in the hot sectors like infrastructure, power etc. But track closely and exit on a reversal – and respect your stop losses, even on the stocks that are fantastic winners. When stocks go down 10% they are going to go further and deeper down; to the point where they are good investments. But at that time, you need money to buy!

  • Anonymous says:

    >A good analysis for a newbie like me. May i request you to analyse Reliance Petro. two weeks ago this share was below 100 but it is continuously rising with market. Is it still good time to buy?

    Regards

  • Siva says:

    >Deepak, good analysis. Thanks. I thought of buying INFY at 1900, but skeptical abt its profitability.
    THanks for your cautions – last paragraph. This mkt rally remind me the rally in year 2005.

  • Anonymous says:

    >Good comments here Deepak….There is still some steam left in the markets before they make their journey south…I’d thread cautiously and use stop-losses prudently…trust me, there is a lot of money sitting on the sidelines…every fall is an opportunity to buy especially in the Infra,power and capital goods…Global cues are buoyant and liquidity is not a problem for the Indian markets (considering the appetite of Indian investors after mega IPOs like DLF and ICICI)… Good luck

  • Trakin says:

    >With it becoming increasingly clear that Rupee is going to further appreciate I really do not think Infy may be a good bet in this quarter. I have written a couple of posts of Rupee appreciation and if I were you I’d not get close to Tech companies at this time …

  • Kaushik Majumdar says:

    >Wonderful analysis. Have linked this analysis to my blog. Hope you don’t mind.

  • sushanth says:

    >Hi Deepak,

    Now that TCS results are out, do you have any opinion on it? They seem to have done a better job in managing rupee compared to Infy.

    What do you say?

    -Sushanth

  • Deepak Shenoy says:

    >Sushanth: TCS has a hedge of $1 billion going into the quarter (Infy had 350 million or so). That’s why TCS hasn’t seen the rupee impact this quarter.

    But $1 billion only covers them for one quarter revenue. Subsequent quarters are still negative – this is just a one-off and the next quarter they will have a hit if hte rupee is at current levels or lower.

  • Uday says:

    >Hi Deepak,

    Today SRF has announced standalone results and stock price is down. Now what do you think about this stock. Kindly put forward you analasys for this stock.

  • SomeOneYouKnow says:

    >This is an interesting analysis and Friday (27/7) did lend it some credibility. Don’t get me wrong, I am not questioning your abilities or your analysis. I completely agree with what you have said, but it was a surprise to see what happened today. with the 290 points that it has gained, the Sensex is back to where it was on Thursday (26/7). Still not able to understand what is driving this phenomenon. It just gets more and more scary to invest especially if one is looking at a long term gain. What say????….

  • Deepak Shenoy says:

    >Yeppers, there is some grinding going on in the markets. I must admit I was wrong in my Friday analysis that this would be a slide downwards; in fact I told another friend to wait till 12 noon on Monday to invest, and that if the markets slide then he shouldn’t invest.

    Two major things have happened since friday.

    1) Result season: RIL announced stellar results on Friday, but Monday and Tuesday haven’t been very kind to them at all! For a company growing at 27% a year, the current P/E is only 22, which is surprising to say the least.

    A lot of good results have come out – like SBI, IPCL, Tata Steel, BEML, NTPC etc.

    2) US markets reversed their moves on Monday and are looking strong today. The dollar slipped back to below 40.50 (it’s some 40.2 today, from 40.5 on friday!)

    What this means is a) fundamentals are strong and b) inflows have substantially increased.

    Today, RBI provided a 0.5% increase on CRR. While current analysis says deposit rates will drop and lending rates will NOT rise, my personal feeling is that lending rates are bound to go up.

    All this mean a bullish market. So the feeling is – was 27/7 a temporary blip? Perhaps it was, or it was an indicator of things to come.

    what I think is: It is a good time to invest, but we can no longer afford to ignore the markets. The fall can come fast, and with current valuations it’s likely to happen within the next few months.

    You can do two things: Hold your money or ride the wave. I’d say ride it but keep a watch on the markets. A 10% slide should prompt an exit.

    For a very long term approach, beyond a few years, there are solid companies in Reliance, BEML and BHEL.

  • Guruprasad says:

    >Brilliant Analysis. Indian software companies seems to be sick by crying fouls due to currency problem. They must learn(When will they do)to come up with innovative products. If they can’t do they should go by CISCO way.If they can’t do this, their success would definitely become thing of past, since low cost labour is catching up with other Asian markets in IT as well as ITES. I don’t know whether they’re aware of this or simply they don’t want to take any risk(For them, this approach could be of great risk)of getting into products on own or through acquisitions. You’ve made great points which is lucid and understandable for common man(financial illiterate)like me. Thanks and do great work and write great articles, but in much lucid style like this.