Company update: Infosys (Outperformer) - Infosys multiple convergence with TCS
Our analysis (in 3 time periods) of PE multiple premium/discount relationship between Infosys (INFO) and TCS on various metrics reveals that there is a case for multiple convergence between the two companies. Leadership, growth underperformance, margin differential and ROE gap are key factors that explain TCS wide premium to INFO. We believe INFO is catching up on most parameters with TCS and as a result we see room to close the valuation gap given improved developed market growth and stable margin delivery. We believe that consistent delivery and stable leadership would help INFO reduce its valuation discount to TCS. We maintain our constructive view on the sector and reiterate our Outperformer rating on INFO with a target price of Rs.1250.
Why does TCS trade at a premium to INFO: TCS currently trades at 23% (5 year average – 18%) forward PE premium to INFO, primarily led by superior growth and margin delivery. This can be seen from its mere 15% higher profit in FY09 to 83% currently compared to INFO. This captures TCS’s accelerated value creation over the past decade.
Stable leadership feeds into sustainable multiples: Steady leadership is a key component of long-term sustainability in earnings multiples. Frequent leadership changes cause strategic shifts, resulting in execution and growth uncertainties. INFO has seen 4 CEO changes in last 8 years, opposed to 1 in the case of TCS. Frequent leadership churn has caused unstable financial performance in INFO , causing a sticky valuation discount to TCS. INFO’s new CEO has been appointed for a 5-year term, which we believe is a good beginning, and important for stability and thereby sustained re-rating.
ROE differential narrowing with better capital allocation: INFO remains overcapitalised compared to peers, and this has weighed on the company’s ROEs. However, we have seen the company return some of the excess capital (recent buyback and dividends), which should marginally narrow the gap with TCS. INFO’s ROEs have moved up from lows of 22% in FY17 to 25% in 3QFY18 but continues to trail TCS’ ROE of 32% (3QFY18).
Metrics convergence to narrow the valuation gap: INFO’s growth and margin gap is narrowing versus TCS, as seen from its LTM $ revenue growth of 6.1% versus TCS’ at 7.1%. We see continued convergence on most metrics, which will drive multiple convergence with TCS over the medium term. While we are still to hear on a detailed strategy from INFO (due in April 2018), we do not expect any material changes and expect the company to focus on execution.
Infosys is a global technology services company based in India. Co. provides business consulting, technology, engineering and outsourcing services. Co.'s end-to-end business solutions include: Consulting and Systems Integration - consulting, enterprise solutions, systems integration and advanced technologies; Business IT Services - application development and maintenance, independent validation services, infrastructure management, engineering services comprising product engineering and life cycle solutions and business process management; and Products, business platforms and solutions, including Finacle™, which addresses core banking, mobile banking and e-banking needs of banks worldwide.
IDFC Securities Ltd., a subsidiary of the Infrastructure Development Finance Company (IDFC) wherein the Government of India holds a 20% interest, is India's leading equities broker catering to most of the prominent financial institutions, both foreign and domestic investing in Indian equities. A research team of experienced and dedicated experts ensures the flow of critically investigated stock ideas and portfolio strategies for our clients. Our coverage spans across various growth sectors such as agriculture, automobiles, Consumer Goods, Technology, Healthcare, Infrastructure, Media, Power, Real Estate, Telecom, Capital Goods, Logistics, Cement amongst other sectors. Our clients value us for our strong research-led investment ideas, superior client servicing track record and exceptional execution skills.
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