Infosys Q3 earnings: Make hay while the sun shines

Infosys Ltd's stock is up by over 7% on Friday after its December quarter earnings turned out to be not as bad as was feared. Amid global demand uncertainty and seasonal weakness, information technology investors were bracing for dismal December quarter (Q3FY24) results from IT companies. But in a partial sigh of relief, Infosys' constant currency revenue had declined sequentially by 1%, whereas the consensus estimate was for a fall of 1.5%.

In a quarter usually impacted by furloughs, revenue growth for Infosys was aided by higher sale of third party items. These are usually part of large or bundled deals where payments are made by clients for hardware or software procured on behalf of them. Sector wise, the performance of the manufacturing, energy and utilities, and life sciences segments was robust, while telecom and hi tech lagged.

But the pain point remains–a gap between deal wins trajectory and revenue growth. The management commentary is still cautious and does not provide much awaited clarity on revenue growth revival as the traction in discretionary and large transformation projects remain weak with slow client decision making.

Infosys has tightened its FY24 revenue growth projection (in constant currency terms) from 1 2.5% to 1.5 2% year on year. "The guidance implies a revenue decline of 1.5% to 0.5% revenue growth in 4QFY24," said analysts at Kotak Institutional Equities. Infosys announced a large deal total contract value of $3.2 billion in Q3FY24, a decline from $7.7 billion in 2QFY24.

However, its net new deal component at around 71% was strong. "Healthy new TCV can aid revenue growth in FY2025E, but lack of actual contract value disclosure constrains visibility," Kotak said in its report. Large deal wins during the quarter included one mega contract, the management said.

Further, Infosys continues to see client interest in cost efficiency and automation related deals. "Very similar to what we have been hearing for the past three months across the industry, Infosys indicated that clients continue to sign new and long term deals, mainly related to cost optimization, while the small deal volume continues to remain under pressure," Nirmal Bang Institutional Equities said in a report.

“Although pipeline remains healthy, many of these large and long term deals are vendor consolidation deals which take longer to ramp up and usually incorporate an element of third party items," it added. Earnings before interest and tax (Ebit) margin was down 70 basis points sequentially at 20.5%.

Headwinds from wage hike and a one off ransomware incident were offset to a certain extent by the tailwinds of higher utilisation and lower costs. Infosys maintained its FY24 Ebit margin projection of 20%–22%. The management is confident of its margin owing to levers such as automation, pyramid rationalization, and utilization.

That said, overall, the pricing has not improved meaningfully due to competitive scenario and muted demand, the management said. Meanwhile, the Infosys stock trades at FY25 price to earnings multiple of around 23 times, according to analysts estimates. While Infosys' fundamentals are robust, its valuation seems expensive unless more clarity emerges on sector's revenue recovery path..