Technical Analysis by Rajiv Singh
Edited by Vani Rao
Eyes on earnings, Infosys rings in 2014 with surprise changes
A week before declaring its third quarter results, Infosys (NSE:INFY) announced several key executive level changes, sending a clear message to clients and investors alike that the tech giant is poised to regain its lost glory.
The Infosys management has elevated two board members, BG Srinivas and UB Pravin Rao, as presidents of the company who would directly report to current CEO SD Shibulal.
“These changes will further enhance our focus on deepening client relationships, increasing market share, and creating service differentiation through innovation and agility in execution,” Shibulal stated in a release.
The announcements that came two weeks after the departure of three senior executives at Infosys, including V Balakrishnan, also saw the elimination of the 30-member executive council that will cease to exist from April 1, 2014.
India’s second-largest software company has divided almost all its businesses between Srinivas and Pravin Rao. While Srinivas will focus on the global markets, Pravin Rao will take care of global delivery and service innovation.
This decision has elicited mixed reactions from the investor community. While Srinivas has long been considered in the race for the top job, the exits of other contenders such as Ashok Vemuri and V Balakrishnan has narrowed down the number of challengers to barely two. Pravin Rao has emerged as the dark horse in the race.
While the recent changes might intensify the ongoing exodus, it is a good move to clean up the organizational structure that was getting too large to handle. Narayana Murthy has taken some risks that are needed to streamline the organization and put in a growth path.
Analysts believe that the new role creation is aimed at testing the prowess of Srinivas and Pravin Rao for a year in the presidential role, to see if they have the requisite leadership skills. Shibulal would the last of the founders to retire in 2015.
Double-digit Wage Hike Results in Thinner Margins
Although Infosys is showing signs of growth, several senior executives have left the Bangalore-based company in recent months. As a result, Infosys is considering a double-digit pay raise to keep its 1.5 lakh workforce motivated.
The attrition rate at Infosys was 17.3% at the end of Q2, the highest among the tier-1 Indian IT providers, illustrating that the company had become a fertile poaching ground for rivals such as Tata Consultancy Services (NSE:TCS), which had an attrition of 10.9% during the same period.
Although analysts hailed the decision to offer higher pay hikes, they underlined that it could impact the company’s margins.
Infosys 3.0 to be Separate Subsidiary
Infosys is all set to separate its new-generation business into a subsidiary, giving it freedom to focus on large outsourcing contracts, while maintaining interest in an area which could be the future growth engine.
As part of the ongoing restructuring in the company, Sanjay Purohit, Senior Vice President for Software Products, Platforms and Solutions, will be named the CEO of the new subsidiary.
Through the products, platforms and solutions (PPS) division set up in 2011, Infosys aims to generate at least one-third of its revenues by 2020.
According to analysts, the initiative that was a key part of Chief Executive SD Shibulal’s Infosys 3.0 strategy, has turned out to be a money guzzler, if one were to exclude the Finacle core banking unit.
WSA on Infosys Q3 Results
Joma Jose, Senior Analyst at WallStAnalyst.com, believes that the recent events at Infosys, just few days before the Q3 results, may indicate not-so-great results. The announcements of structural changes at this point of time may mainly be to instil faith in the investors even if the overall results fail to make an impression. “By dissolving the executive committee, Infosys longs to do away with its top heavy management and get a leaner and simplified structure, which would ensure smooth and quick flow of communication sans any red tapism. The company’s recent pay hike announcement hints at its renewed focus on retaining the lower-rung employees who are being poached by its peers.”
If we look at the historical earnings performance of the company as shown above, Infosys has provided five positive surprises and two shocks in the past eight quarters with regard to its EPS and sales performance. During Q2 2014, Infosys has surprised investors with 1.89% higher sales of INR129.65 billion as compared to an estimate of INR127.24 billion. However, on the EPS front, Infosys did not meet the estimate and fell short by 8.35%.
Implied Volatility (Mid) – Infosys 3500 Call Option – Expiry 30 Jan 2014 (Implied Volatility 38.90)
Implied Volatility (Mid) – Infosys 3500 Put Option – 30 Jan 2014 (Implied Volatility 36.93)
Historically, the implied volatility of Infosys has played a major role prior to its pre-earnings trading sessions. This time around, implied volatility of Infosys 3500 January expiry options is still around the 40s as compared to high 80s during the previous few quarters. This also indicates a relatively subdued investor’s expectation this time. WSA also expect a relatively quiet quarter, even though recent incidents and top management exodus points us towards a negative surprise on the EPS front. The chart below shows estimate of sales and EPS for Infosys.
Infosys is expected to report a 25% growth in sales to INR130.99 billion in Q3 2014 from INR 104.24 billion in the year-ago period. However, we do not expect the stock to see more than a 5% movement on either side from the current trading level post earnings. The current stock prices already seem to factor the possible revenue growth expectations and any diversion to that could lead to a downside risk. The volatility is likely to remain relatively low this time during the earnings day.
However, as a long-term investment, Infosys remains one of our favorites at this point. Going forward, we expect the company to improve its margins. Moreover, the stock prices are likely to see 4,000 plus trading levels in 2014.
Amidst all the estimation and speculation, it will be interesting to see what numbers the Infosys comes with. It remains to be seen whether the Q3 results will bring cheers to investors or give way for another reason to be worried about the Indian IT major and it’s ever increasing list of concerns.