Infosys has the most attractive risk-reward in the IT space, says ICICI Securities

At a time when most experts remain bearish on the IT sector and believe that the near-term outlook for the IT space is worsening, brokerage house ICICI Securities sees a 26 percent upside in IT major Infosys (INFY).

The brokerage has retained its buy call on the stock with a target price of ₹1,641, indicating an upside potential of almost 26 percent from its current market price of ₹1,305 (as on June 13, 2023). According to ICICI, headwinds are largely priced in and Infosys has the most attractive risk-reward in the IT space.

"INFY is trading at an attractive valuation of 19.6x 1-year forward P/E closer to its last 15-yr average multiple of 19x. We believe soft revenue growth in FY24 is already factored in the current stock price, and the announcement of mega-deal wins will potentially help the stock re-rate from these levels. INFY has already announced 4-5 deal wins in the current quarter (Q1FY24) and has a good mega deal pipeline with some deals in advanced stages. We believe the risk-reward ratio is favourable with a limited downside (8-9 percent) for INFY from current levels in a bear case scenario of an 8-9 percent YoY CC (constant currency) revenue growth in FY25E and FY26E," explained the brokerage.

It continues to value INFY at 23x on FY26 EPS of ₹80, discounting back by 1 year at 12 percent to arrive at a target price of ₹1,641 (unchanged), implying a 26 percent potential upside.

Stock price trend

Infosys has fallen over 8 percent in the last one year and over 14 percent in 2023 YTD, giving negative returns in 4 of the 6 months in the current calendar year.

The stock has lost nearly 2 percent in Juen so far after an over 5 percent jump in May. However, it shed 12.3 percent, 4 percent, and 3 percent in April, March, and February, respectively. In Jan, the stock was up 1.7 percent.

While the last one year has not been weak for the IT major, it has given multibagger returns in the last 3. The stock has surged over 150 percent from its COVID low of ₹509.25, hit in March 2020.

Earnings

Infosys delivered weak March quarter (Q4FY23) results. In Q4, the firm posted a 7.8 percent year-on-year (YoY) rise in consolidated net profit at ₹6,128 crore. It gave 4-7 percent revenue growth guidance for FY24 amid macroeconomic uncertainties, well below analysts' expectations of a 10.7 percent growth. This revenue growth guidance is the slowest in six years. Before this, the IT firm posted a 3 percent revenue growth in fiscal 2018.

Infosys, during the Q3 earnings announcement in January this year, had raised FY23 revenue guidance to 16-16.5 percent against the previously projected band of 15-16 percent.

Its consolidated revenue in constant currency terms jumped 15.4 percent YoY in the fourth quarter of FY23 at ₹37,441 crore. On a sequential basis, the revenue fell by 3.2 percent.

Q1 forecast

Going ahead, the brokerage believes that Infosys' Q1FY24 (June quarter) results ate also likely to be weak. It said that INFY’s FY24 revenue guidance of 4-7 percent YoY CC optically looks soft vs peers due to a weak Q4FY23 exit growth rate. 

However, it is healthy because the CQGR (compounded quarter growth rate) of 2.3-2.9 percent implied by the mid to high end of the guidance is higher than INFY’s pre-covid CQGR. It is also higher than CQGR implied by the guidance of larger peers like Accenture (ACN), Capgemini (CAP) and TCS, it pointed out.

Barring the guidance miss in Q4FY23, Infosys has a good track record of upgrading or retaining the guidance over the course of the year and delivering near the higher end of the guidance during Salil Parekh’s tenure. ICICI believes this credible performance is likely to continue.

It also mentioned that INFY’s management mentioned that the mega-deal (>US$500mn) pipeline, as well as the overall deal pipeline, are strongly characterised by a higher share of cost-takeout and efficiency gain deals. In fact, in the current quarter (Q1FY24), it has already announced 4-5 deal wins, it added.

The brokerage also highlighted that Infosys has gained revenue market share during the subsequent two years post dip in world GDP growth during the previous two crises (GFC and Covid pandemic) due to the high propensity of clients for offshoring and outsourcing in order to reduce costs.

Digital capabilities

As per the brokerage, Infosys also has strong digital capabilities around AWS, Azure, GCP, Salesforce, Servicenow, etc., and most of these SaaS players have retained or slightly upgraded their CY23/FY24 guidance during Q4FY23 results – Servicenow, Intuit, Workday, Datadog, Hubspot have slightly upgraded their guidance, while Salesforce and Atlassian have retained their guidance. 

Plus, the CQGR implied by the guidance of these SaaS players points towards a pick-up in growth in the second half of FY24. Similarly, the consensus expects revenue growth to revive in CY24 and CY25 post dip in CY23, which is positive for IT services companies like Infosys, which derives 62 percent of its revenue from digital services (including cloud and other newer technologies).

Margins

However, ICICI believes INFY’s margins will likely remain subdued over the next three years (FY24-26) given: 1) the company’s focus on winning large/mega deals that are typically margin dilutive in initial years, 2) the benefit of pyramid optimisation is largely behind, 3) little scope to improve offshore effort mix which is near optimum levels, and 4) travel costs as a percentage of revenue to increase gradually vs FY23, though may not go back to pre-covid levels.

The above-margin headwinds can be partially offset by an improvement in utilisation (300-400bps below optimum levels currently) and a reduction in sub-con costs (200-300bps above pre-covid levels currently). ICICI estimates a 90bps decline in margins over FY23-26E for INFY.

Risks

As per the brokerage, key downside risks to its rating include 1) double-digit revenue growth assumption for FY25E led by structural demand drivers for the industry and the fact that technology absorption as a percentage of global GDP is increasing may not pan out as expected, 2) delivery slippages due to the exit of senior management, and 3) structural margin reduction due to focus on winning large integrated deals.