Infosys: Holding Steady Amid Client Spending Softness

seekingalpha06-19

Infosys Limited provides consulting services globally, but is facing delays in client discretionary projects post-pandemic.The market for digital transformation consulting is growing, but Infosys ...

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Thomas Barwick Investment Outlook Infosys Limited (NYSE:INFY) provides various consulting services to companies around the world, and its stock has shown some resilience after the pandemic. I previously wrote about INFY in June with a Hold outlook due to moderate growth in client delays. Companies continue to delay discretionary spending or transformation projects, seeking to focus on cost-takeout efforts that are less profitable for consulting firms like INFY. Until management can reignite meaningful organic revenue growth in a tough client spending environment, I remain on Hold for Infosys Limited stock. Infosys Overview And Market Bengaluru, India-based Infosys was founded in 1981 to provide a wide array of information technology consulting and outsourcing services to firms worldwide. The company obtains new clients via direct sales, outbound marketing and business development efforts, and through partnerships. INFY’s top revenue segments in terms of sales revenue are, in order of amount, from the sectors of Financial Services, Manufacturing, Retail, Energy and Communications. Per a 2022 market research report by Business Research Insights, the global market for digital transformation strategy consulting was an estimated $53.3 billion in 2021 and is forecast to reach $234 billion by 2031. If achieved, this growth would represent a CAGR of 16.13% from 2022 to 2031. The primary reasons for this expected growth are the increasing use of digital technologies in organizations of all sizes, along with their growing complexity. Also, many organizations are making the transition from legacy, on-premises systems to cloud-based or hybrid environments with complicated architectures. The industry is fragmented, but large competitors include the following:  Globant EPAM Slalom Accenture Deloitte Digital McKinsey BCG Ideo Cognizant Technology Solutions Capgemini Company in-house development efforts.  The firm is active in other consulting, outsourcing and advisory markets worldwide. Recent Financial Trends Total revenue by quarter (columns) has fallen due to a contract renegotiation and continued software in client demand for digital transformation and other discretionary engagements. Operating income by quarter (line) has dropped due to lower gross profit and revenue pressures.   Seeking Alpha Gross profit margin by quarter (green line) has fallen slightly as a result of a contract renegotiation with a large financial services client; Selling and G&A expenses as a percentage of total revenue by quarter (orange line) have remained flat.   Seeking Alpha Earnings per share (Diluted) have moved up due to the booking timing of interest income during the quarter.   Seeking Alpha (All data in the above charts is GAAP.) For balance sheet results, INFY ended the quarter with $3.3 billion in cash, equivalents and short-term investments with no debt. Over the trailing twelve months, free cash flow was $2.88 billion and capital expenditures were $266 million. The company paid $79 million in stock-based compensation in the last four quarters. In the past 12 months, INFY’s stock price has gained 14.7% vs. that of the SPDR S&P Software & Services ETF’s (XSW) rise of 10.1%, as the chart indicates below. Seeking Alpha The table below is a handy reference for major financial and operating metrics in the most recent reporting period.       Metric Amount   EV/Sales (\"FWD\") 3.7   EV/EBITDA (\"FWD\") 15.5   Price/Sales (\"TTM\") 4.0   Revenue Growth (\"YoY\") 1.9%   Net Income Margin 17.1%   EBITDA Margin 22.7%   Market Capitalization $73,800,000,000   Enterprise Value $71,540,000,000   Operating Cash Flow $3,150,000,000   Earnings Per Share (Fully Diluted) $0.76   2025 FWD EPS Estimate $0.75   Rev. Growth Estimate (\"FWD\") 4.9%   Free Cash Flow/Share (\"TTM\") $0.70   Seeking Alpha Quant Score Hold - 2.92   Click to enlarge (Source: Seeking Alpha.) Why I’m Neutral On Infosys INFY is still experiencing slow growth in discretionary and digital transformation projects, putting downward pressure on revenue growth. Clients are continuing to focus on cost takeout and non-discretionary spending, while delaying decisions on new projects due to continued macroeconomic uncertainty. INFY is especially heavy in the BFSI sector, and its discretionary project share is higher for this sector, leading to stronger negative effects as these clients reduce their discretionary engagement spending. Employee utilization (ex-trainees) is not bad at around 83.5% but still below the firm’s target range of 84% - 85%. Utilization rate is an important metric for consulting firms as it indicates how efficient the company is at utilizing its employees on engagements. Many consulting companies are facing the same soft demand environment for non-discretionary projects, so management has to make the difficult trade-off of choosing to keep trained employees during periods of slow work, resulting in reduced earnings or letting more employees go. A number of firms have been choosing the former to keep employees on despite lower project activity, as they believe a period of economic growth is just ahead. The graphic below shows the frequency of certain keywords and terms in the most recent conference call between management and analysts.   Seeking Alpha The chart is noteworthy in that it shows the \"headwinds\" the company and its clients are facing regarding macro conditions and uncertainties. Also, the firm’s Middle East clients have been experiencing greater uncertainty due to regional tensions. Compared to competitor Wipro Limited (WIT), INFY is being valued at higher multiples on potentially higher revenue growth and net income margin.         Metric Wipro Infosys Variance   EV/Sales (\"FWD\") 2.5 3.7 52.0%   EV/EBITDA (\"FWD\") 12.5 15.5 23.7%   Rev. Growth Estimate (\"FWD\") 2.1% 4.9% 136.2%   Net Income Margin 12.3% 17.1% 38.6%   Operating Cash Flow $2,110,000,000 $3,150,000,000 49.3%   Click to enlarge (Source: Seeking Alpha Data.) The consulting industry has been in the doldrums for some time after the end of the pandemic, as clients and prospects have been more conservative in their spending habits in an inflationary and rising interest rate environment. We’re starting to see major consulting companies let go of lower-performing employees, such as McKinsey & Company, but the industry hasn’t yet moved to larger layoffs. INFY has a strong balance sheet and may have opportunities to acquire select tuck-ins or even a transformational target if it likes. But for now, the company is suffering through the current period of slower spending activity largely intact.  Until management can restart meaningful organic revenue growth, I’m on Hold for INFY.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":null,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.24.2","shortVersion":"4.24.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2444455211"}