Saturday, April 5, 2014

Infosys - a bit of a fallen yet expensive Star

Infosys is one of the biggest success stories of India's IT services export industry. Its founders are widely respected and have positively influenced many aspects of India - from the aadhar card system to corporate governance to fighting corruption. Its the second largest employer of H1-B professionals in the US. Infosys top management love to market the egalitarian approach and there are stores of the promoters cars being checked at the gate like everyone else. The question really is that after 33 years of existence does it belong to the value category.

There have been some negative reports about corporate governance standards at Infosys falling. There as been some talk earlier about the return of co-founder Narayana Murthy being about getting his son into the upper echelons of the company's management. The company also has lost some senior tenured talent which in the consulting & software business is not good at all.

1. How big is the moat?

Grade B+ moat
  • Broadly 25% of the staff is onsite and 75% or so is offshore. Essentially Infosys is in the business of providing high quality software and solutions using lower cost and high quality talent. Now globally where the reason for off-shoring is cost the lowest cost player wins. In the talent game the lowest cost talent is NOT the highest quality talent so the rule about lowest cost producer moat for commodity businesses cannot apply in its purest form here.
  • From the financials it seems to me that Infosys is more picky about clients and growth than TCS as their revenue per employee is higher and so is their average compensation per employee higher.
  • So far the IT services sector in India has seen explosive growth - so fast that the effects of competition on the margin were not seen as well. Now that the Industry is not growing as fast I worry that growth and margins will both be under pressure. The good news is that the returns on capital are so high that it should not make this a bad business for a while.
  • Brand - I don't think that the brand here matters much while making sales - customers are unlikely to pick Infosys over IBM, Accenture, TCS, Wipro or some of the other majors on brand alone.
  • Employees - Infosys seems to have excellent HR systems for training and development but so do the others.

2. Risks

  • There is lots of cash lying on the balance sheet which might be used for non-value accretive overpriced acquisitions
  • The company has not found avenues for deployment of retained earnings
  • Margins have gone down despite the falling rupee from FY2009 till FY2013
  • Growth rates lagged industry leaders - which was the company's strong point earlier
  • Corporate governance standards reducing - these are just from news stories and I have been unable to verify them

3. Financials

  • ROE has fallen to 24.8% in FY2013 from 32.8% in FY2009 as the company has been accumulating cash on the balance sheet that has not found proper uses
  • Return on invested capital has actually gone up to 49% in FY2013 from 33% in FY2009- which should be the case because of the falling rupee
  • Zero debt as expected
  • Dividend % of earnings is around 29.7%
  • Debtors % of sales stands at 17.6% which is better than TCS at 21%+
  • Net margins are similar to TCS at around 22% (including the interest earned). They used to be higher back in the day.
  • Revenue per employee for Infosys is around 26 lakhs per year against TCS at 23 Lakhs per year.
  • Exposure to north america is very high. Industry exposure not so concentrated.

4. Soft factors

  • Promoter shareholding is very low at around 15% making this a truly professional company. And even that 15% is shared among various promoters.
  • The company has 143 patents as of Dec 2013 and 533 patent applications out.Value of patents and their relevance is a totally different question.
  • Director shareholding - promoters are like professionals on the board. Most of the directors hold shares in the company.
  • Insiders & Aberdeen asset management since 1st Jan 2014 have sold 0.03% of the company. Last reported transaction was on 12th of March.

5. Pricing

  • Overall revenue growth over the 4 years has been about 16.8% CAGR and profits growth has been about 12% CAGR.
  • Currently trading at 19.8 times TTM earnings. If earnings grow at the same pace as the last 5 years for the next 5, and then 10% after than for 5 years and then 5% till perpetuity this should be bought at an earnings multiple of 10 or so. I would not call at a value investment over than. That said if you already hold it I would not get rid of it at this point as the company has a huge head start on the midcap players and could capitalize on these to go back to its original path.

BSE: 500209 | NSE: INFY | ISIN: INE009A01021 

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