May 21, 2009

Analysis: Infosys technologies

Financials
The company declared fairly good results for 2009 with a topline and bottom line growth of around 30%. The ROE has been maintained at 30%+ levels and in addition the company continues to hold almost 10000 Crs of cash on its books.

The company continues to maintain one of the highest net margins (around 30%) in the industry. In the addition the various asset ratios such as fixed asset turns and working capital turns continue to be maintained at very high levels (in excess of 5)

Positives
The positives of the company are apparent. The company has very high margins, high returns on capital, has shown extremely high growth rates in the last 10 years and has one of the best managements in the country.

Risks
The positives of the company as far as the financial parameters are concerned are also the risks faced by the company. Contrary to the media reports, I don’t consider the recession to be a serious issue for the company in the long run.

The recession is bound end sooner or later. The company has substantial scale to ride out the recession. Inspite of the huge drops in the IT services market the company has been able to maintain its ROE and other financial ratios. At the same time, the company has now grown into a 4.5 billion dollar company and now competes with the likes of accenture and IBM.

Companies like accenture earn net margins in the range of 8-10% (with ROE in excess of 50%). These companies are fairly profitable companies in their own right, however not as obscenely profitable as the Indian vendors such as Infosys.

I personally feel, the tier I vendors have a good business model and will be able to do well in the long run. However their margins and profitability should eventually converge to the same levels as their foreign counterparts as they really don’t have any special competitive advantage over their foreign competitiors.

The above convergence could result in decent topline, but a lower bottom line growth.

Competitive analysis
I wrote about
asian paints in an earlier post. I have worked in asian paints and have worked in infosys too. Both are good companies and have good managements. At the risk of comparing apples and oranges, I think asian paints has a higher competitive advantage over its competitors than a company like Infosys.

I have personally been involved in discussions within the company wherein we would struggle to differentiate ourselves with a competitor. I cannot say that for companies like asian paints (brand, distribution etc).

In spite of the above, infosys is a very good company with a decent business model. The biggest difference between a tier I company such as infosys and any other Tier II company is however the management (which I discuss below).

I personally feel, management quality is extemely important in the IT services business. This business has seen a lot of change and will continue to do so. A superior management will be able to drive the business better than the others.

Management analysis
Infosys is known for its management quality and corporate governance. Lets look at how it fares on the various points

- Management compensation : Management compensation seems to be fair. The CEO and top managers make less than 1% of the net profit. In addition the promoters/ managers have never awarded themselves any stock options till date.
- Capital allocation record : The capital allocation record is extremely good. Infosys is one of the few companies which explicitly state their ROE/ ROC objectives in the annual report (twice cost of capital on average capital employed). In addition, in view of the high cash holdings the company has raised its dividend to 30% of net profit from 2008 onwards. In summary the company has a fairly rational capital allocation process.
- Shareholder communication – The company has one of best disclosures and communication practise. I would advise you to read the annual report for this reason alone. The management has explained each P&L and Balance sheet transaction in detail and given the reasoning behind each. Most companies don’t bother with such disclosures at all.
- Accounting practise : Extremely conservative. Case in point – The company has adopted AS30 standard (mark to market accounting) a year in advance. This is the same standard which a number of other companies are resisting as they are likely to have huge MTM losses in the current fiscal due to rupee depreciation.
- related party transactions : Limited to transactions with subsidiaries.
- Performance track record : Very good. The company has always exceeded their guidance (although they under commit everytime). The company has performed quite well for the last 10+ years and have managed the growth fairly well.

Valuation
The company currently sells at a PE of around 14-15. I would not consider the company to be highly undervalued. Infosys of 2009 is not the same company as it was in 2000. In 2000, this was a very rapidly growing company, with commensurate risks. The company will have lower growth rate in the future , but at the same time it also has lower risks due to its scale and maturity of its business model.
I would roughly estimate the intrinsic value to be between 2000-2200 per share which can be revised based on how the company fares in the future. However it would be foolish to expect the company to fare as well as it has done in the past.

conclusion
Infosys is now a mature, well run company with above average growth. It has a shareholder friendly and competent management. The company should provide decent returns in the long run, but one should not expect very high returns.

Some Q&A
- Is it not smarter to invest in a smaller fast growing IT services company?
Yes, but the risk is also correspondingly higher. So it a different risk reward scenario in case of smaller IT services company

- Will cost pressures and other currency related issues not impact the company’s performance?
These issues impact all IT companies. However one can expect the management to respond smartly to these environmental changes by globalizing further. The management has successfully responded to the dot com bust, growth related issues and other challenges in the past. It is logical to expect that the management would continue to respond well to any current and new challenges.

Disclosure : I own the stock. Please also read disclaimer on my blog

18 comments:

mkd said...

Hi Rohit,

I think you have nailed the point when you say that Infosys-2009 is a different company than Infosys-2000.

Most people have an expectation mismatch by looking at the earlier timeframe and expecting something similar in future.

As you rightly said, Infosys-2009 is a mature company with excellent management. It is going to deliver 15-20% kind of returns which should be acceptable given the lower risks involved.

I personally think that the risk-reward ratio is highly favourable towards investors in case of Infosys. Of all stakeholders involved, Infosys always seems to give highest weightage to the investors.

Unfortunately, I had to recently part with my Infosys stock as I had written covered calls before Election mania began.

But without doubt I plan to acquire it back.

MKD

sudhanshoo said...

Very good and brief analysis of Infosys, though I would be interested to know how you arrived at Rs 2000-2200 as the intrinsic value for the company.

Also it should be wise to analyze Infosys as a global firm and comparisons are more apt with IBMs and Accentures of the world.

Additionally, one can end up underestimating the risks (a) of volatile currencies in a more global world and/or (b) protectionism.

Neerav said...

One another measure of good management i takeis how good a company is in treating its employess. So far I have mostly heard good things about the company from people who work there. they have rewarded people well with ESOPs and there are lots people i know who have been working there for 5-6 years.

Same cannot be said about other cos like Wipro/TCS.
Finally in people based business this is what will matter most.

sumi said...

Hi Rohit,

I am glad your intrinsic worth is coming close to what I am arriving at.I really hope I get to buy infy at discount in the next few months. Management is definitely one of their strong points.

regards,
sumi

Nandy said...

Hi Rohit,
What I love about Infosys is its Management Quality and Shareholder friendliness. I think a premium to this is very important bcoz it really reduces your risk perception. And all this, while being a high-growth company, all along.

On valuations, the EPS of the company has growth at a CAGR of 38% in the past 10 years. And toning it down to about 20-21% still makes me feel that about 2800 is a good intrinsic value for the comany. With a 50% MOS, around 1200-1400 has been a great buy for me. Have bought at this point and will buy again when it comes back there.

Great Analysis overall.

Nandhitha

Charu Gupta's Blog said...

Dear Rohit,

very good analysis. I specially like the management part of it. Really well researched. It is very insightful. I agree that the company has a good long term future, though it cannot grow at a very high rate because of its size and scale.

I had also done a qualitative analysis of Infosys and even i'm positive on the company. Good work.

Regards,
Charu

Anonymous said...

Infosys is definately a long term story and can be held without any time limits to it. Not sure if it is a value buy at current market or value. There might more attractive stories in current senario which can beat infy's performance in next 5-10 years but identifying it is a challege and till that time we can park money in Infy stock.

Rohit Chauhan said...

Hi mkd
i agree, the biggest issue around infosys is the expectations people have. they still expect infosys to grow like 200 crs company. it is a good company and good business to invest as long as you are fine with reasonable returns and patient too.

sudanshoo
it have arrive at the instrinc value by assuming a growth of 12-15% for a CAP period of 8-9 yrs and terminal value of 12 time PE.
i agree the comparison of the company has to be with the global vendors. the closest one would be accenture. diffcult to do for ibm as one cannot get the breakdown for IT services alone

i am not too worried about currency fluctuations. in the medium to long term it evens out. protectionsm could be an issue, but i think it is overated. companies like infosys are now globalizing and can get around this issue like the toyotas and hondas of the world have

regards
rohit

Rohit Chauhan said...

Hi neerav
yes, the company treats its employees fairly. they pay a reasonable wage and do not exploit employees which one cannot say for a lot of other indian vendors or even foriegn companies.

sumi - then i guess we are using similar assumptions to value the company.

Rohit Chauhan said...

Hi nanditha
i am personally not comfortable with a growth assumption of 20% in the future. the past growth really cannot be used as a reference point. at their size the topline could grow fast, but for various reasons i cannot see the bottom line growing as fast. however 12-15% growth is not trivial

regards
rohit

Rohit Chauhan said...

hi charu
yes the company has a decent long term value. also the management can be trusted to do the right thing for its shareholders

anon - infy has moderate risk return characteristics. so one cannot really compare it with other options out there. there a definitely a lot of other companies which could offer higher returns. infosys is now a far more mature and stable company with low to moderate returns

Another Idiotic Analyst said...

Hi Rohit,
Just a counter view...as u rightly pointed out, a lot of investor still have huge growth expectations from Infy..like it was a much smaller company..growing at even 12-15% consistently on such a huge base is a big, big challenge.
people's expectations are higher. if infy cannot match these high growth expectations, dont u think it will hit the PE of the stock? infy used to trade at 35+ PE once upon a time. now its at 15+ PE. if it cant grow in line with 'expectations', what stops investors from dumping it to a 8-9 PE levels? (of course, i wud luv if that happens..i will buy! :-) )

regards
Neeraj

Rohit Chauhan said...

Hi neeraj
One of most common mistakes by a lot of investors is to correlate PE with growth. PE is correlated to growth, return on capital and how long that excess return can be maintained.

a PE of 7-8 implies no growth and an ROE of less than 10%. that is not the case with infosys. infosys continues to have a very high return on capital which should continue for a decent amount of time. A PE of 15 reflects the low growth expectations and more versus the PE of 35 when the expectations were higher.

if the company can maintain the current ROE and a growth of 10-15%, a PE of 20 is reasonable

i would suggest you to take the DCF model and play with the growth, ROE and CAP period assumptions. I have done that myself and you can download it from the download link in the side bar

A PE of 8 can happen, but i would not wait for it as i could be a low probability scenario

regards
rohit

Doubting_Investor said...

Rohit,

Looking at the recent global downturn other comparable companies like TCS & Wipro have tried reducing head count, but not Infosys. They continue to burn their hard earned cash on people on bench.

This will work to the benefit of Infosys if the economy recovers fast, but will prove to be detremental otherwise. If the global economy continues to be bad, they will be forced to layoff, but that will happen after they have wasted their reserves.

Have you considered this risk factor?

Anonymous said...

Hi Rohit,
have you ever analyzed penny stocks?
Will you please look at Sanraa media? it's financials are not very much like typical penny stocks.

It's PE is moderate, it is dividend paying, profit making company. Debt is also moderate.

regards
Ani

Dilip Lillaney said...

good company ... but expensive

Avadhut said...

Hi Rohit,
Superb Analysis.
I want to know your vuews about R Systems International. It is trading below its Book Value per share. Other things look good too.

Thanks
Avadhut

Anonymous said...

Sir,
I want to invest in infosys with a 10 years time horizon.

Can you just give your hunch that in next 10 years even in worst scenerio how much returns will infosys be able to give to shareholders, what will be the price after 10 years ! I am just seeking an idea from you , I will be responsible for my investment descion, I have read your disclaimer.

My problem is that I want to invest in infosys but a bluechip company today may not remain bluechip after 10 years...so somewhat handicap to take a final call on infosys ...please help me out.