Infosys'' FY08 EPS may exceed estimates: JP Morgan

Bhavin Shah of JP Morgan expects Infosys to post an EPS of Rs68 in FY07 and Rs88 in FY08, and he further adds that Infosys' FY08 EPS may even exceed estimates.

In his disclosures, Shah clarifies that he does not own either this scrip or any of the others he talks about in this interview.
He says that the US slowdown is unlikely to impact offshore spending much, and he expects utilisation rates to move up. However, he says that higher utilisation will expand margins only marginally. Looking forward to earnings, amongst IT midcaps he is bullish on Sasken.

CNBC-TV18 shares with domain-b its interview with Shah:

Have you upped Infosys' EPS in terms of FY07-08? What are your new price targets?
Our new price target is Rs2,375, that's the December '07 price target. We had no other choice but to increase our estimates, given the numbers that Infosys has pulled out — Rs68 for FY07 and Rs88 for FY08.

The FY08 numbers could prove to be conservative. Our forecast suggests a steep fall off in the growth rate from 50 per cent plus this year to 30 per cent. Chances are that if the demand environment remains healthy, the company could do better than that. So we leave an upward bias to those estimates.

When Infosys spoke about the dipstick survey that it had done with its clients for FY08, they said that at this point they could see no sluggishness in terms of spending from their large clients in FY08. Why then would you presume that growth would slow down from 50 per cent to 30 per cent?
Looking at the current year, going back three or four months, we talked about the fact that Infosys planned for stronger growth. But I'm not so sure they planned for a 50 per cent growth. So it's probably just a bit of a conservative attitude that we have, given the size of the company and the number of employee additions.

But in all honesty, there definitely is room for the growth to be closer to the 40 per cent range. This year I think there are some one-off benefits; currency depreciation plays some role as well. But one could think of about 40 per cent as a more possible number. In other words a significant upside over estimates is feasible if the demand environment remains the way it is.

Are there signs that the demand environment is slacking and there may be a slowdown in the sort of sales that technology companies are seeing by the time we step into '08?
There are few things we can look at. If you look at the corporate earnings growth in the US, it has outperformed people's expectations, but it is slowing. So I think if you derive IT spending growth based from that, there will be some degree of slowdown.

So the big question is whether or not it is going to hurt the offshore business much. However, we don't think it should affect the offshore trend significantly. I think there may be some cutbacks here and there on infrastructure spending, but not so much on the offshore.

Looking at the technology demand in general, even though there have been a lot of concerns about the slowdown in US over the last few months, the unit demand, the consumption of the end products for technology, whether it is personal computers or handsets, have been very strong.

Obviously a lot of it is also coming from emerging markets, which is not directly Infosys' target market. But certainly the demand for technology has remained very healthy and infact bounced back in the last three months.

What do you expect to see for Infosys in terms of the operating margins they delivered this time, and the fact that billing rates might have moved up?
Some of the margin improvement is obviously because of the currency and also the falling of the visa cost. But they could see higher utilisation coming through. There is definitely still some room for margin expansion.

The pricing trend has just begun to show positive signs and obviously it's a very important leverage. I won't expect major expansion, but some more small improvements in margin are still possible in the coming quarters.

Is there any scope for Infosys actually trading at a higher PE multiple given the kind of growth that it's showing this year and possibly will go on to replicate next year or do you think the stock performance will broadly mimic the kind of earnings growth it has been able deliver?
I would not really count on a PE multiple expansion. The stock is fairly expensive on a Discounted Cash Flow, DCF, valuation. Obviously a high growth company tends to trade above its DCF fair value in a period of high growth, and Infosys is clearly a high growth company.

I am not going to focus too much on DCF, but the expansion of PE multiple is not something that one would be very comfortable with. If it happens in a very good market we will see, but that's not how I would define my investment thesis.

What are your expectations now from Satyam and TCS?
I think the reserves across the board are likely to be pretty healthy. With TCS we do expect close to 10 per cent QoQ operating profit growth. We do think that there is room for upside in all the big companies.

But I do not think that one is going to see fireworks from other players. Infosys is really doing well with some of their big accounts. So there is some company specific development here on top of generally good overall demand environment.

Execution capabilities are clearly top notch. But one shouldn't expect this kind of mid double-digit growth from other companies. High single digit or 10 per cent kind of sequential growth is something that we would expect.

Again, on a full year basis, if Infosys gets to 50 per cent numbers, we can expect TCS to be at 40 per cent and others to be in 30 per cent range. So we do not expect any other company, except maybe Cognis, listed in the US, to come close to this 50 per cent kind of number for YoY growth.

Just to revisit that Infosys versus TCS debate, given what you just said and given the kind of numbers which are being thrown about, do you think Infosys just stole a little bit of march again in that comparison game?
When the TCS numbers come out, it will become apparent that the two companies now have very similar profits. Infosys is growing a bit faster than TCS, but TCS is also a great company.

The fact that Infosys achieves this kind of results, does not necessarily mean that other companies are bad choices. And that's one unique thing about the Indian software industry. There are at least half a dozen very strong companies in this space in India. So we are positive generally on this space; Infosys, TCS are both in the long side of our portfolio.

A quick word on Wipro because that's been the under performer this quarter. From a stock perspective, it's lagged all its peers by quite a margin in the market. Are there any apprehensions, which the markets are probably trying to price in?
I think it is clearly not growing as fast as Infosys and TCS, and maybe that's partly reflected in there.

Also, in terms of what they might report, we are expecting new high single digit 7-8 per cent QoQ growth in volume and flattish margins.

We are not expecting the kind of margin expansion that Infosys has reported. So maybe that's partly why it might have underperformed.

Is there anything that you track from the midcaps? What are your expectations on those stocks?
I guess one company that I pay a little more attention than the others to, for myself, is Sasken. They do some work that overlaps with hardware and handset software. I do think that they have clearly got some good opportunity in the product side and the handset software area. So we are positive on Sasken.