An Indian IT Service Provider With Strong Fundamentals

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India’s economy has over the last decade benefited greatly from the outsourcing boom which moved business support and IT jobs over to the subcontinent. Cities like Bangalore have flourished as a result of this development, turning itself into something of an IT Mecca. While analysts were alarmed at the news of India’s growth slowing to 5%, there is still plenty of value and growth left in the area. Infosys (NYSE: INFY) is one of the companies that were best able to capitalize on the Indian IT boom, and while it seems fairly valued at the moment, still appears to offer plenty of growth potential.

Stock at a Glance

Infosys, headquartered in Bangalore and founded in 1981, provides a range of business consulting, technology, engineering and outsourcing services to customers worldwide. Richly diversified, it has become one of India’s best known IT companies. The company has a market cap of around $30 billion and over 150,000 employees. The stock is down about 5.5% in the last year and offers a 1.6% dividend yield.

Indian Growth Slowdown

On Thursday it was announced that Indian GDP growth had slowed to 5%, below the analyst estimate of 5.5% as well as government and central bank projections. Analysts feel that the number is realistic, given the sharp fall in industrial production and weakness in exports. This figure is likely to fall further over this fiscal year, as the Indian economy remains plagued by high inflation, infrastructural problems and a large fiscal deficit.

Infosys Earnings

Despite the gloomy macro-economic outlook in India, Infosys once again delivered a decidedly upbeat quarterly report. For Q3 2013, the company announced EPS of $0.76 versus a consensus of $0.72, with revenue also in well above estimates up 6.3%. The company also raised its guidance for the full-year ending March 31st 2013 to a revenue guidance of at least $7.45 billion versus a consensus of $7.32 billion. According to management, the fundamentals of the company have remained intact despite the economic difficulties, and they remain optimistic about the company’s ability to meet the revised guidance.

According to at least one analyst, this beat also bodes well for one of Infosys’ main competitors, the quasi-Indian US-based outsourcer Cognizant (NASDAQ: CTSH). This company is additionally well positioned to benefit from the US healthcare reforms, which may lead to a great number of outsourcing jobs streaming into India. In terms of revenue there isn’t much to separate these two rivals, though Cognizant’s quarterly earnings growth of 18% looks a lot better than Infosys’ 6%. Also, Infosys looks a lot cheaper than the US outsourcing firm.

Key Indian rival Wipro (NYSE: WIT), who competes in the IT services segment, posted mixed results for its last quarter, with weak results from its outsourcing division. The company is overall less optimistic about future earnings growth, although the outlook for the Indian IT sector still looks pretty good due to its persistent cost advantage over the developed markets.

Valuations and Metrics

Infosys currently trades at 17.34x earnings, cheaper than the industry average and certainly cheaper than Cognizant’s P/E of 23.11 and Wipro’s 19.22. The price to book and price to sales are both a bit high though at 4.44 and 4.18. The company has a high operating margin of 27% beating both Cognizant’s 19% and Wipro’s 17% soundly. The return on equity is also high at 27.50%. Moreover, the firm has an excellent balance sheet with 4.08 billion dollars in cash and zero debt. The company has a leveraged free cash flow of about $930 million which should provide enough cash for M&A activities as well as R&D.

Bottom Line

While India’s GDP appears to be struggling, the mighty Indian IT division still offers good prospects for growth. Operating with a labor cost advantage that’s hard to beat, the division’s dominant position worldwide is likely to remain in place. Infosys, one of the main companies that are active in this area, is doing very well in terms of earnings. With strong growth, an enviable balance sheet, and a valuation lower than that of competitors, the company seems like a good bet.

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