From Star to Favorite Whipping Boy to Star Again

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Infosys (NYSE: INFY) was set up in July 1981 at Mumbai. It is currently headquartered in Bangalore India and Infosys has an ADR i.e. the stock in the form of ADR is listed on the American Stock Exchanges. It is one of the bellwether stocks of India which had underperforming in recent times. Infosys was a darling of the Indian investors and there were buyers willing to buy the stock even at a P/E of 100! YES!! 100!

But things soon changed. For many quarters Infosys was not able to meet its quarterly guidance and the stock got beaten routinely. The company had a huge cash pile and it was looking around for acquisitions, but things never materialized. It was accused of being overly conservative and not being able to strategize. There were management changes and the company also took to protecting its margins even at the cost of a deal and all hell broke loose on Dalal Street. But come January 2013, when the company announced its December 2012 results and the sun was again shining brightly on Infosys.

 The stock took quite a beating on the Indian stock markets, but the company has reported stellar Dec. 2012 quarter earnings and the stock has surged.

<table> <tbody> <tr> <td> <p>INFOSYS- In USD Millions</p> </td> <td> <p>As of 30<sup>th</sup> Sep 2012(Quarter)</p> </td> <td> <p>As of 31<sup>st</sup> Dec 2012 (Quarter)</p> </td> </tr> <tr> <td> <p>Sales</p> </td> <td> <p>1,790.27</p> </td> <td> <p>1,724.40</p> </td> </tr> <tr> <td> <p>Gross Profit</p> </td> <td> <p>622.57</p> </td> <td> <p>779.08</p> </td> </tr> <tr> <td> <p>Net Profit</p> </td> <td> <p>429.72</p> </td> <td> <p>415.60</p> </td> </tr> <tr> <td> <p>Gross Profit Margin</p> </td> <td> <p>34.78%</p> </td> <td> <p>45.18%</p> </td> </tr> <tr> <td> <p>Net Profit Margin</p> </td> <td> <p>24%</p> </td> <td> <p>24.10%</p> </td> </tr> </tbody> </table>

The gross profit margin and the net profit margins are higher than normal manufacturing companies and are good ratios for an IT/ITEs company.

JPMorgan and Barclays Capital upgraded their ratings on Infosys to “overweight” from their respective “neutral” ratings after the Company announced good December 2012 quarter earnings. Citigroup had a “buy” recommendation earlier as well.

Infosys is curretnly trading at a P/E of 16.79 making it an extremely attractive buy- Its peers are trading at P/Es of more than 20. Infosys itself was trading at a P/E of 24 about a year back.

<table> <tbody> <tr> <td> <p>INFOSYS</p> </td> <td> <p>Dec 2011 to Dec 2012</p> </td> <td> <p>Dec 2010 to Dec 2011</p> </td> <td> <p>Dec 2009 to Dec 2010</p> </td> </tr> <tr> <td> <p>Share Price Growth</p> </td> <td> <p>13.95%</p> </td> <td> <p>19.7%</p> </td> <td> <p>24%</p> </td> </tr> </tbody> </table>

This shows that the management moved fast even in the aftermath of the subprime crisis and in the ensuing and ongoing Euro Crisis and posted double digit growth even amidst the global turmoil. The share price has come down subsequently as the management had taken a stand of not cutting down on margins even if it meant losing contracts. Subsequently, management realized that they were losing profits and market share to competitors and they have realized their folly and have now taken steps to rectify their mistake and are now chasing volumes. Infosys’ head of sales & marketing, Basab Pradhan confirmed to JPMorgan that the company had become flexible in negotiated pricing for volume growth.

Apart from pricing, the company has also taken other initiatives. It has started a star account program, wherein senior personnel focus on one key client rather than multiple clients. Infosys also motivates employees to focus on clients which would offer more meaningful revenue growth over the long period.

Infosys is a zero debt company which implies that it is well positioned to weather economic storms. Recessionary conditions have made many debt ridden companies to seek debt restructuring or face bankruptcy. The absence of debt is a very positive point for Infosys.

Here's a breakdown of its annual payout ratios :

<table> <tbody> <tr> <td> <p>Dividend Payout Ratio (Cash Profit)</p> </td> <td> <p>Mar 2012</p> </td> <td> <p>Mar 2011</p> </td> <td> <p>Mar 2010</p> </td> <td> <p>Mar 2009</p> </td> <td> <p>Mar 2008</p> </td> </tr> <tr> <td> <p> </p> </td> <td> <p>33.86</p> </td> <td> <p>55.86</p> </td> <td> <p>25.32</p> </td> <td> <p>24.15</p> </td> <td> <p>44.35</p> </td> </tr> </tbody> </table>

The above clearly shows that the company makes generous dividend payments.


In the Dec 12 quarter it acquired 53 clients on a gross basis and 25 new clients on a net basis. It did 8 large deals worth $ 731 million. It has acquired Lodestone and taking into account $104 million from Lodestone it has given a growth guidance of 6.5%.

Infosys has also acquired Lodestone Holding AG for $349 million, which it will finance from its formidable war chest.

Headquartered in Zurich, Lodestone advises international companies on strategy and process optimization, and provides business transformation solutions enabled by SAP. The combination of the breadth of capabilities delivered by Infosys and Lodestone's deep experience of driving transformational change, is expected to provide clients across the two companies, a world-class team to accelerate transformation and innovation led growth.

The deal is also in line with its strategy of focusing on consulting and systems integration, which together account for 31% of the total revenue.

Management expects this deal to generate revenues over a two to five year period. Some analysts are of the view that while this will strengthen the company’s presence in Europe, it will take some time for the benefits to flow through given the current Euro Zone crisis. Moreover, Lodestone derives nearly three-fourths of its revenues from Switzerland and Germany, which are the relatively resilient European economies.

Peer Group Comparison

There is another Indian company in the IT space which has an ADR in the USA. Its name is Wipro (NYSE: WIT). A third company which is listed on the NASDAQ is Cognizant (NASDAQ: CTSH). All these are excellent companies in the IT space which have a good deal of operations in India. A snapshot of the performance for the quarter ended Dec. 31 and other indicators are given below:

<table> <tbody> <tr> <td> <p> Figures in US$</p> </td> <td> <p>INFOSYS</p> </td> <td> <p>WIPRO</p> </td> <td> <p>COGNIZANT</p> </td> </tr> <tr> <td> <p>Revenue</p> </td> <td> <p>US$ 1.724 billion</p> </td> <td> <p>US$ 1.718 billion</p> </td> <td> <p>$1.892 billion</p> </td> </tr> <tr> <td> <p>Net Income</p> </td> <td> <p>US$ 415.60 million</p> </td> <td> <p>US$  272 million</p> </td> <td> <p>$    276 million</p> </td> </tr> <tr> <td> <p>ADR/Share price</p> </td> <td> <p>US$ 52.60</p> </td> <td> <p>US$ 9.30</p> </td> <td> <p>US$ 77.63</p> </td> </tr> <tr> <td> <p>P/E Ratio</p> </td> <td> <p>17.27</p> </td> <td> <p>19.24</p> </td> <td> <p>23.52</p> </td> </tr> <tr> <td> <p>Beta</p> </td> <td> <p>0.66</p> </td> <td> <p>0.82</p> </td> <td> <p>0.94</p> </td> </tr> <tr> <td> <p>10 year return</p> </td> <td> <p>3063.36%</p> </td> <td> <p>2020%</p> </td> <td> <p>1243.08%</p> </td> </tr> <tr> <td> <p>Market Cap</p> </td> <td> <p>US$ 29.832 billion</p> </td> <td> <p>US$ 23.235 billion</p> </td> <td> <p>US$ 23.337</p> </td> </tr> </tbody> </table>

From the above chart, it is quite clear that Infosys has a better net profit margin amongst all the 3 companies, the lowest P/E and also available to the American investors at a lower price when compared to Cognizant. Infosys has also given the highest return over a ten year period.

Wipro has debt on its books ($668.77 million) as of March 31 whereas Infosys is completely debt free.

In a research paper titled-“Why not diversify internationally with ADRs” by Mahmoud Wahab and Amit Khandwala, it was found that if Americans include just 7 ADRs (50% of the investment portfolio) and the balance is in S&P 500, there was a drop of 43.7% in risk. The authors also report that the investment weights play an opposing role as far as risk and return are concerned. As far as risk is concerned, the higher the ADR weight of the investible surplus, the greater the risk reduction benefit, with the highest risk reduction appearing at 50% in ADRs and 50% in S&P 500. But as far as return is concerned, highest incremental return happens at 10% of the investible surplus in ADRs.


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