Even after the recent developments at Infosys, both companies are expected to deliver similar revenue growth in FY17
The scrip of Infosys Technologies has been reacting sharply to any misses or blips registered in operational performance. This is reflected in the stock's behaviour in recent months, after it disappointed investors on multiple fronts.
Among recent developments is the company's revenue missing Street expectations in the June quarter, the first of this financial year. More importantly, the company trimmed its earlier full-year constant currency revenue growth expectation in July by 100-150 basis points. It now expects this metric to grow between 10.5 and 12 per cent.
The most recent pressure point seems more structural. After cancellation of a contract from Royal Bank of Scotland (RBS), following the British vote to leave the European Union, the company management has said the latter development ('Brexit') is a real concern. It remains watchful on its forecast and hopes a clearer picture will emerge around October.
Thanks to these concerns, the Infosys scrip is down six per cent over the past month, as against a one per cent fall each in its closest peer, Tata Consultancy Services (TCS), and the benchmark S&P BSE Sensex.
In fact, after trading at a minor premium to TCS for a brief while, it now trades at a 25 per cent discount. Infosys trades at a relatively undemanding valuation of 15 times the one-year forward estimated earnings. The key question now is whether the valuation gap is justified. Not quite.
One, even after the recent developments at Infosys, both companies are expected to deliver similar revenue growth in FY17 (with the difference in growth rate only one to two percentage points), by the consensus estimate.
Second, the near-term headwinds from Brexit could have a bearing on TCS’ revenues as well. In fact, TCS derives a higher proportion of its revenues from Europe; Infosys has relatively lower exposure to this market.
Third, as TCS has been missing the Street’s revenue estimate for some quarters, its high valuations could be at risk to any unfavourable development.
“Operationally, this valuation gap implies the market expects the annual revenue/net profit growth gap between TCS and Infosys of five-six per cent to open up and persist into the long term (five years),” write analysts at JPMorgan, in a recent report on Infosys.
If Infosys never manages to even partially close this gap with TCS for the next five years, the current valuation gap is justified and will endure, it adds.
The silver lining is that Infosys has managed to address the issues it faced in the consulting business in the June quarter and expects to put up a better show in the ongoing one. Most analysts believe in the management’s implementation capabilities and say it is witnessing improved momentum in deal wins.
Thus, despite near-term headwinds from Brexit, the Street continues to remain positive on Infosys. The average target of analysts polled by Bloomberg this month of Rs 1,278 for the share is an upside of 25 per cent from current levels. Investors can, thus, use this correction to enter the stock.
Photograph: PTI Photo
