Markets
Infosys’ mixed signals give cold vibes to investors
Summary
- Infosys shares have outperformed peers this year, but lingering concerns over client spending and muted growth prospects have left investors uneasy, clouding near-term outlook.
Infosys Ltd's September quarter (Q2FY25) results fell short of market expectations, leading to a nearly 5% drop in its share price on Friday. This was despite the IT major reporting a sequential constant currency (CC) revenue growth of 3.1%, exceeding consensus estimates. Excluding the retail sector, all other verticals grew quarter-on-quarter.
As anticipated, Infosys raised its FY25 CC revenue growth guidance from 3-4% to 3.75%-4.5%. However, investors were left unimpressed by the cautious tone of the management, which dampened hopes for a robust rebound in discretionary IT spending.
Read here | Infosys beats Wipro as European clients spur growth
“The guidance was upgraded by just 50 basis points at the top end despite a strong 3.5% CQGR in H1, implying a muted CQGR of ~0.5% over H2FY25. This indicates that despite client pessimism bottoming out, a lift-off in discretionary spends still eludes us," Motilal Oswal Financial Services Ltd said in a report. Simply put, revenue recovery will be gradual and only in pockets. CQGR is short for compoundquarterly growth rate. One basis point is one-hundredth of a percentage point.
According to the management, there are limited signs of recovery in discretionary expenditure, particularly outside the US banking sector. While the pricing environment is stable, the company has not seen any change in clients’ decision-making behaviour. Q3 will be impacted by furloughs, although these are unlikely to extend as they did last year.
Amid this, Infosys has deferred FY25 wage hikes, which shall now be in January 2025 and April 2025. Further, Infosys won 21 large deals in Q2FY25, but total contract value fell around 42% sequentially and 69% year-on-year to $2.4 billion. Large deals are focused on cost optimization, the management said.
Earnings before interest and tax (Ebit) margin in Q2FY25 was flat at 21.1% versus expectations of a sequential expansion. Margin tailwinds from project Maximus and favourable currency movement were partially offset by higher amortization costs from acquisitions and elevated variable costs. Ebit margin guidance for FY25 was maintained at 20-22%.
“With muted growth anticipated in Q3 and Q4, and partial wage revision (for junior) scheduled in Q4 will have an incremental impact on margins," cautioned analysts at Prabhudas Lilladher. On the positive side, pyramid rationalization and offshoring would negate some of the adverse margin impact.
“Considering the headwinds above and margins miss in Q2, we are cutting our margin estimates by 40bps each in FY25E and FY26E and 20 bpsin FY27E," it added.
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Meanwhile, expectations of a demand recovery, especially after the US Federal Reserve cut interest rates in September, have provided some optimism for IT stocks. In this calendar year so far, Infosys has outperformed the Nifty IT index with 22% returns. At FY26 price-to-earnings, the stock is trading at a multiple of nearly 26 times, on par with Tata Consultancy Services Ltd, showed Bloomberg data.
Also read | Why Indian IT firms dread US economic uncertainty
Infosys will likely benefit more than its peers from a recovery in discretionary IT spending when it materializes. However, for now, valuation comfort remains elusive.
