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Morningstar | Infosys Posts Strong 1Q on Back of Digital Growth; Raises Growth Outlook; Shares at a Premium

We were surprised by the strength of Infosys’ first-quarter performance with the firm posting healthy low-teens revenue growth and recording its highest ever large deal with a total contract value of $2.7 billion. The first quarter was a validation of Infosys’ improving position within the digital services market as the company signed 13 key large deals across multiple industries while announcing industry-leading digital services growth of 41.9% year over year in constant currency. To that end, digital services constituted 35.7% of total revenue in the first quarter. Infosys’ performance contrasts to Cognizant’s recent struggles and TCS’ solid yet unspectacular start to the year. Infosys’ commentary on the important financial-services industry (an area we are paying special attention to) cited some challenges given M&A in the U.S. and capital market impacts in Europe. However, unlike peers, Infosys’ tone was slightly more optimistic due to recent client wins and a buildup in its deal pipeline. The firm raised its full-year revenue growth outlook to 8.5%-10% from 7.5%-9.5% and maintained its operating margin target of 21%-23%. After the quarter, we reiterate our fair value estimate of $8.80 per share (INR 630) and narrow economic moat rating. With shares at a premium, we’d seek a wider margin of safety before investing in the name.

For the quarter, revenue rose 10.6% year over year to $3.13 billion (increased 12.4% in constant currency). Digital revenue grew 41.9% year over year in constant currency to $1.12 billion, while core revenue increased 0.6% to $2.01 billion. The stark difference in growth rates reflects the “new” versus “legacy” nature of the IT services industry and the need for vendors to appropriately pivot to the higher growth and higher margin digital services arena. From a business segment perspective, all segments grew double-digits apart from retail and life sciences and reflect broad strength across Infosys’ portfolio.

Infosys’ operating margin dipped 100 basis points sequentially and 320 basis points year over year to 20.5%. The margin was impacted by foreign exchange, expected compensation increases, increased visa costs, and acquisition dilution. Meanwhile, the firm countered these pressures with better utilization and other cost efficiencies. We continue to expect the full-year margin to be in the realm of 21%-23% and in line with guidance.