Infosys is changing again! Digital push may come at a price, but can do it good

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By Aurobindo Das

India’s second-largest software firm is switching lanes. It’s making a push for a higher digital play. But there is a price to pay – that is, margin.

The IT major’s March quarter earnings played out on expected lines. But if going by new CEO Salil Parekh’s future strategy, one thing is unmistakably clear – digital is the way to go and if the company will have to sacrifice margin, so be it.

The IT giant is keen that it moves away from its former CEO Vishal Sikka’s legacy. This is evident from the fact that Infosys is seeking buyers for two firms — Skava and Panaya — acquired during Sikka’s tenure to build a so-called software plus services model, and will instead look to seal more deals in the growing digital economy.

Digital revenue at the end of quarter to March stood at 26.8 per cent, a growth of 3.6 per cent QoQ in constant currency terms.

“We have huge strength in digital and agile digital services,” Parekh told analysts on Friday after he presented the company’s annual results in Bangalore. “We will execute our strategy around the four pillars of scaling our agile digital business, which is today $2.79 billion in revenue.”

The company put out a 6-8 per cent revenue growth guidance for FY19 in constant currency terms against 5.8 per cent in FY18. But margin took a backseat, as the guidance was scaled down to 22-24 per cent from 24.3 per cent in FY18 due to investment in digital business. This will help Infosys gain market share, brokerage Edelweiss said in a report.

“Lower margin guidance and softer-than-expected commentary are likely to be perceived negatively by Street. However, we maintain Infosys as our top pick led by a) strong deal win momentum b) digital-focused strategy in place c) undemanding valuations (14.9x FY20E EPS) and d) high dividend yield. Maintain ‘BUY’ with revised target price of Rs 1,419 (Rs 1,475 earlier),” the brokerage said.

Investments towards digital, although margin dilutive, will be positive for long-term growth, given rising relevance of these services for clients, Edelweiss said. “Renewed focus on digital will help Infosys drive revenue outperformance in coming years.”

The Bangalore-based company said fourth quarter profits grew 2.4 per cent to Rs 3,690 crore and revenue by 5.6 per cent to Rs 18,083 crore. Infosys had reported profit of Rs 3,603 crore on revenue of Rs 17,120 crore between October and December 2017. Operating margin stood at 24.3 per cent.

Parekh’s plate is full – scaling up agile digital business, energising core via AI and automation, reskilling employees and expanding localisation.

This means the IT outsourcer will step up investments to achieve these objectives, which has led to lowering of FY19 operating margin guidance to 22-24 per cent, from 23-25 per cent for FY18.

“We cut FY19E and FY20E EPS 0.7 per cent and 4.2 per cent, respectively as i) investments in building sales and digital capabilities will lead to 90 bps and 70 bps margin dilution, respectively; and ii) Rs 130 billion payback to shareholders reduces other income,” Edelweiss said.

There are positive takeaways as well. Strong deal momentum and the move to distribute $2 billion cash to shareholders in FY19 over and above regular dividend are seen as tailwinds.

As the marquee software exporter gets busy resetting its priorities and letting go off its past luggage, it might mean a short pause in wealth creation from investor perspective.

Source: Economic Times