We downgrade Infosys from from ‘buy’ to ‘sell’ and lower our price target to R2,750 a share (earlier R4,050), thus valuing the stock at 13x FY16e EPS — near its three-year low. We also lower our EPS forecasts for FY15, FY16, and FY17 by 4%, 11%, and 15%, respectively, to reflect our lower revenue and margin estimates than previously.
Infosys’ strategy is likely to keep it a trend follower in the medium term. We believe the next wave of growth for large Indian IT vendors will be led by infrastructure services and BPOs. These account for less than 15% of Infosys’ revenue compared with 25-35% for TCS and HCL Tech. Infosys is now beginning to focus on these segments, but, in the next 2-3 years, we think Infosys’ large base (nearly 85%) in the slower growing applications segments will remain a drag on revenue growth relative to peers. With recent commentary indicating the company is having trouble jumpstarting growth in its base segment as well, we think a turnaround could take longer than expected.
We are puzzled by the company’s decision to report margin increases in the past few quarters, even as revenue growth trajectory has begun to slow once again. TCS and HCL Tech had reported margin drops for at least 2-3 years during phases of investment, after which margins recovered as revenue growth improved.
We were appreciative of the company's margin reset in FY13 in a bid to gain market share and view the recent reversal in that strategy and curtailment in critical areas of spending such as sales headcount as premature.