Infosys: HOLD

Upcoming events & guidance upgrade hold the key Weak Q4FY11, muted guidance (esp. on margins) and ongoing management restructuring (namely the exit of Mr. Mohandas Pai) lead us to downgrade our FY12E EPS est. by ~7% to ~Rs 140; introduce FY13E EPS est. at ~Rs 170. We now assign a lower target FY12E P/E of 20x (lower than 5yr median at 21x vs. 24x earlier; implied PEG at ~1x).

Revenue guidance positive: Client additions of 34 (incl. 7 Fortune 500 clients), closure of 4 transformational deals (>USD 30 mn) & 6 large deals (42 in last 8 qtrs) indicate demand buoyancy. Thus, resulting in a 18-20% YoY revenue growth guidance in USD terms. While Q1FY12 QoQ topline guidance is lower at ~1% to ~2%, the implied QoQ topline growth (in USD terms) for the remaining qtrs at 5.5% to 5.9% appears strong.

EPS guidance is lower: At 8-10% YoY growth even in USD terms builds-in ~300bps margin decline on account of 1) currency volatility (~1%), 2) lower utilization assumption, & 3) wage inflation (~10-12% offshore and ~2-3% onsite). We believe upsides exist from (1) utilization rates given current low base (Q4FY11 utz ex-trainees at ~75%) as volumes improve in 9mFY12, (2) Insurance vertical returns to QoQ growth and Telecom vertical at least shows some traction (where management indicated improvement in deal pipeline in Q4). We are not banking on any pricing change from Q4FY11 which can surface given strong demand & uptick in discretionary spend. Q4FY11 is an aberration: due to 1) ~6% QoQ decline in Top 6-10 clients (Q4 rev share: ~10%), & 2) continued weakness in Telecom & Insurance (Q4 aggregate rev share: ~19%). From FY03 till date, ex year of Lehman debacle, Infosys has reported a positive vol. growth in Q4.

Outlook: While Q1FY12E absorbs margin pressure from wage hikes/ visa costs, from Q2 onwards we expect 2-3 qtrs of consistent QoQ growth in EPS. In the interim, we would monitor two critical events to review our call 1) TCS results on 21 April 2011 & 2) Infosys board meet on 30 April 2011 on finalization of its leadership succession, post retirement of Mr. N. R. Narayana Murthy as Chairman of the Board in August 2011.

Management changes

We believe the value addition and contribution of Mr. Mohandas Pai to Infosys is best exemplified from the statement of Mr. Narayan Murthy. We produce these words of appreciation in the current report to highlight this organization restructuring at this current juncture: "Mohan has been an early adopter and a keen anchor builder of Infosys. It is difficult to imagine Infosys without Mohan’s passion, commitment, joie-de-vivre and intellect. We all know that he is taking this painful decision, since he has much bigger projects in the horizon - nation building. The Board and every Infoscion thank Mr. Mohandas Pai for his wonderful contribution and wish him great success in his future endeavors."

Our revised TP of Rs 2,803 implies a 6% downside. Downgrade to HOLD.