Infosys Q3 Review: Resilient margins amidst macroeconomic headwinds, Q4 margins expected to see 60 bps benefit

IT major Infosys delivered a better than consensus revenue growth while the margin was in-line with consensus estimates. Infosys, on Thursday, posted Q3 profit for FY 24 at Rs 6,106 crore, down 7.3 per cent as against Rs 6,586 during the third quarter of FY23. It posted revenue from operations at Rs 38,821 crore, marginally up by 1.3 per cent in comparison to Rs 38,318 crore during the same period last year. Aditi Patil, Equity Research Associate, ICICI Securities, said, “Infosys reported revenue decline of 1 per cent QoQ CC vs.

our/consensus expectations of -0.2 per cent/-1.5 per cent QoQ CC. Decline was driven by furloughs, one-time impact due to McCamish cyber incident and continued weakness in discretionary spends. Impacted verticals of communication, retail, hi-tech and financial services continue to report weak revenue growth. Manufacturing vertical growth has been resilient due to a ramp-up in large deals won in previous quarters.”

Infosys’ FY24 revenue guidance was revised to 1.5 per cent- 2.0 per cent and operating margin guidance at 20 per cent- 22 per cent. Apurva Prasad, Vice President – Institutional Research, HDFC Securities, said, “The cut/narrowed guidance implies only marginal growth at the top-end in Q4 despite the benefit from the Liberty Global deal ramp-up and normalization of the McCamish impact. The relative weakness is emanating from (1) a higher mix of discretionary services in Infosys’ portfolio with slower activity on digital programs, a steep decline in top 11-25 accounts and pressure on renewals (sub-USD 1bn large deal renewal TCV as compared to USD 1.5bn quarterly average), (2) extended furlough impact in Q4 and increased competition from captives, and (3) attrition in senior management to competition.”
Prashanth Tapse, Senior VP (Research), Mehta Equities Ltd, said, “Infosys has revised and tightened its FY24 revenue guidance to 1.5-2.0 per cent and operating margin guidance at 20-22 per cent. December usually being a seasonally weak quarter with macroeconomic headwinds, Infosys remained neutral.”

“The improving trajectory beyond FY24 is premised on (1) benefits from project ‘Maximus’ driving margin improvement – utilisation, pricing, pyramid, delivery efficiency, (2) new deal wins around cost optimization, SAP cloud, and (3) relative strength in manufacturing and E&U verticals (28 per cent of revenue). Near-term upside potential is capped especially if macro recovery is protracted,” HDFC Securities’ analysis report stated.

Infosys’ new large-deal TCV

Infosys reported a healthy large-deal TCV of $3.2 billion (-1.8 per cent YoY) with 71 per cent net new deals. Net new deals at $2.3 billion were up 94 per cent YoY. “Deal pipeline remains healthy, even after large deal signings in the last two quarters. Management is seeing lower traction for digital transformation and discretionary programs with stronger focus on cost reduction and increasing interest in Generative AI,” said Aditi Patil from ICICI Securities. Infosys won 23 large deals, including one mega deal. It won 8 large deals in manufacturing, 6 in financial services, 4 in EURS, 2 each in retail and communication. Region-wise, it signed 10 large deals in North America, 9 in Europe, 3 in RoW and one in India.

Dhruv Mudaraddi, Research Analyst, StoxBox, said, “The absence of mega deals has slowed deal momentum during the quarter. Furthermore, a sequential decrease in EBIT margins can be attributed to the impact of two months of wage hikes and the absence of one-time sales observed in Q2FY24. Despite the challenging environment, Infosys showcased its execution capabilities, with operational efficiencies realized under ‘Project Maximus.’ Infosys’ strategic focus on generative AI, digital, cloud, cost efficiency, and automation positions the company for long-term value creation and market leadership.”

Abhishek Shindadkr, Research Analyst – IT Services, InCred Capital, said, “Large deal TCV was encouraging which, together with stability in the leakage portfolio and conversion of the deals won in H1FY24 to revenue, imply bottoming of the YoY growth trajectory. This, coupled with a reasonable valuation relative to peers, drives an upgrade in our rating to ADD (from HOLD earlier) with a higher target price of Rs 1,668 vs. Rs 1,496 earlier.”

Infosys’ margins

Infosys reported EBIT margin of 20.5 per cent, -71bps QoQ. Headwinds of 70 bps from wage hike (effective 1 November, 2023) and 60 bps from McCamish cyber-attack incident were partially offset by tailwinds of 50 bps from cost optimisation, including high utilisation and low SG&A and a 10 bps benefit from currency movement, said a report by ICICI Securities.

Going ahead

Infosys’ Q4FY24 margins, according to brokerage firms, is expected to see a 60 bps benefit owing to a one-time impact of the McCamish incident in Q3FY24 and some benefit from reversal of furloughs.

“We have factored Infosys’ USD revenue growth at 2.6/6.1/8.0 per cent for FY24/25/26E, implying 0.7 per cent growth in Q4 and 2.3 per cent/1.8 per cent CQGR for FY25/26E. EBITM factored at 21.0/22.0/22.0 per cent for FY24/25/26E, translating into an EPS CAGR of 13 per cent over FY24-26E. Infosys trades at 22x and 20x FY25/26E valuations, which is a ~18 per cent discount to TCS’ valuations (at a historical average valuation discount),” said HDFC Securities report.

Dhruv Mudaraddi from StoxBox, said, “We will be keeping a close eye on the management guidance regarding the demand outlook in the BFSI and Hi-Tech verticals that are currently facing pressure, feedback on clients’ CY24 budgets, deal ramp-up visibility, and the strategies in place to manage margins effectively.”