The q1fy24 result of Infosys is expected to be weak, which is already known to the market. However, we view INFY’s FY24 revenue guidance of 4-7% y-o-y CC as healthy. This is because the implied compound quarterly growth rate (CQGR) of 2.3-2.9% at the mid to high end of the guidance is higher than INFY’s pre-COVID CQGR of 2.2%. It also surpasses the CQGR implied by the guidance provided by larger peers such as Accenture (ACN), Capgemini (CAP), and TCS. With the exception of a guidance miss in Q4FY23, Infosys has consistently upgraded or maintained its guidance throughout the year and has delivered results near the higher end of the guidance under the leadership of Salil Parekh. Therefore, we expect this trend of credible performance to continue.
INFY possesses robust digital capabilities, particularly in the areas of software-as-a-service (SaaS) and hyperscalars. As a result, the company is well-positioned to capitalise on the anticipated resurgence in demand for digital technologies throughout the estimated period of FY25-26.
Demand is healthy for most SaaS players as they have either retained or slightly upgraded their CY23/ FY24 guidance during Q4FY23 results. Additionally, CQGR implied by the guidance of these SaaS players points towards pick-up in growth in H2FY24/H2CY23. Similarly, consensus expects hyperscalar revenue growth to revive in CY24 and CY25 post dip in CY23 . This is positive for IT services companies like Infosys, which derives 62% of its revenue from digital services.
We expect INFY’s margins to remain under pressure in the upcoming three years (FY24-26) due to several factors. Firstly, the company’s strategic focus on securing mega deals typically results in margin dilution during the initial stages. Secondly, the benefits of pyramid optimisation have mostly been realised, leaving limited room for further improvement in offshore effort mix, which is already close to optimal levels. Additionally, travel costs as a percentage of revenue are projected to gradually increase compared to FY23, although they may not reach pre-COVID levels. However, some of these margin headwinds can be partially mitigated by enhancements in utilisation rates and reductions in sub-contractor costs. Our estimates suggest a decline of 90 basis points in INFY’s margins from FY23 to FY26. INFY is trading at an attractive valuation of 19.6x 1-year forward P/E closer to its last 15-year average multiple of 19x.
Anticipated soft revenue growth in FY24 is already reflected in the current stock price of INFY. However, the potential announcement of mega deal wins has the possibility to trigger a re-rating of the stock, leading to an upward adjustment in its valuation from the current levels.
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INFY has already announced 4-5 deal wins in the current quarter (Q1FY24) and has good mega deal pipeline with some deals in advanced stages.
We believe risk-reward ratio is favourable with limited downside (~8-9%) for INFY from current levels in a bear case scenario of 8-9% y-o-y CC revenue growth in FY25E and FY26E. We continue to value INFY at 23x on FY26 EPS of Rs 80, discounting back by one year at 12% to arrive at a target price of Rs 1,641 (unchanged), implying 30% potential upside; maintain Buy rating on the stock.