Up until recent years, it was great to be in the outsourced information technology services business. Now that just feels “so Big Blue ago.” In a world of apps, the cloud and cheaper task management over expensive outsourced teams on massive projects, it feels as though there has been a race toward zero in the field of IT outsourcing. The reality has not actually been as bad as the perception, but investors just do not want to own IT-sourcing shops any longer.
Shares of Infosys Ltd. (NYSE: INFY) were hit hard after its most recent quarterly earnings came in $0.13 per share, meeting estimates, and the $581 million in net income compared with $571 million in the same period a year earlier, but operating was down to $658 million from $693 million. Infosys’s fourth-quarter revenue rose to $3.06 billion from $2.81 billion a year earlier, barely beating a street expectation of $3.05 billion.
Infosys forecast its annual revenue growth for the year ahead to be in a range of 7.5% to 9.5% in constant currency terms, and it sees operating margin coming in between 21% and 23% for the year.
24/7 Wall St. wanted to take a view on a “day after” approach to see if the move lower in its share price seems unwarranted or if there might be more of an IBM-like cloud hanging over Infosys.
The overall earnings report didn’t look all that devastating on the surface, but analysts on Wall Street seemed to all be jumping out of the same airplane with big analyst downgrades. Monday’s top analyst upgrades and downgrades showed an entire army of simultaneous downgrades:
- Citigroup downgraded it to Neutral from Buy.
- Investec downgraded it to Hold from Buy.
- Morgan Stanley downgraded Infosys to Equal Weight from Overweight.
- Merrill Lynch lowered its rating to Neutral from Buy after the earnings report, noting that the profits were below expectations despite the 2020 outlook coming in mostly as expected.
- Credit Suisse also downgraded it to Underperform from Neutral, effectively issuing the equivalent of a Sell rating.
- Nomura/Instinet cut its rating to Reduce from Neutral, another equivalent of a Sell rating.
CFRA recently kept its Hold rating and $11 price target, but the firm trimmed its fiscal year 2020 EPS estimate to $0.51 from $0.60 and set a 2021 target of $0.60 EPS as its planned compensation hikes with an average cost per software employee rising by about 5% will compress margins.
In the earnings report, Salil Parekh, CEO of Infosys, talked about a transformation taking place at the company:
We have completed the first year of our transformation journey with strong results on multiple dimensions including revenue growth, performance of our digital portfolio, large deal wins, and client metrics. This is a reflection of our increased client relevance stemming from our focus on digital, positioning, and long-standing client relationships. Our planned investments have started yielding benefits. As we look ahead into fiscal 2020, we plan to deploy various measures of operational efficiencies across the business.
One driving force in the transformation was that Infosys is targeting large deals, and the press release noted recent wins and ongoing relationships with the likes of Kraft Heinz, Citizens Energy, Siemens Gamesa Renewable Energy and so on. And on the company’s plans to hire 10,000 people across the United States, it has hired about 9,100. Along with high demand from employers of all walks, there also appears to be some pressure around the Trump administration’s actions on H-1B visas limiting some workers from coming on board.
Wedbush Securities had maintained a Neutral rating on Infosys ahead of earnings on April 2, but the firm raised its target price to $12.00 from $9.00 at that time, when the shares were trading at $11.09.
Unfortunately, Infosys looks to be caught between a rock and a hard place. It is not cheap on a basic earnings multiple (17ish), and it has a higher attrition rate among employees, with higher compensation costs meeting conservative revenue growth expectations all pressuring gross margin.
Infosys shares were trading at $10.97 ahead of Friday’s earnings, and the stock fell as low as $10.39 afterward. Its shares were down 1.5% at $10.41 late on Tuesday, in a 52-week range of $8.40 to $11.38. The consensus target price was $10.91.
The in-house view for Infosys would be that investors just might find better growth and more excitement elsewhere. There doesn’t seem to be a scenario that is dreadful, but there’s no real attraction that screams upside here either.