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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!


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