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Infosys battered by volatile markets – and margins

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Pity those investors who have given Infosys the benefit of the doubt over the last couple of years. Shares in India's second-largest IT outsourcer fell by the most in 10 years on Friday. The one-fifth fall came after the company announced that it had missed its revenue guidance for its end-March full year. It followed that up with a weak and vague guidance for this year. The hope was that some of the recovery seen in the outsourcer's third-quarter would continue. But earnings before interest, tax, depreciation and amortisation fell 5 per cent year-on-year in the past three months.

All of India's outsourcers face a challenging global economy, but that has not helped Infosys to fine-tune its forecasting. Shares in the company have fallen by at least 5 per cent on its results days for the past 10 consecutive quarters. The 5.8 per cent growth in revenues for 2012-13 was below a 6.5 per cent guidance. Yet the broad 6-10 per cent top line growth forecast for this year does not give investors much faith that its visibility has improved further. Or that the group has much confidence – India's IT industry body expects the country's IT exports to pick up by 12-14 per cent over the next 12 months.

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The main problem for Infosys is an increased vulnerability to downturns. The one-third of revenues it derives from discretionary services such as consulting and systems integration is bigger than its peer group's. As a result, swings in this higher margin segment have a big impact on Infosys's profitability. When companies were spending on expensive services through the boom years, Infosys's operating margin was humming along at about 10 percentage points above the likes of Tata Consultancy Services. Over the past year, Infosys's 26 per cent margin looks to have fallen short. TCS reported a 27 per cent margin for the first three quarters. It will release full-year earnings next week.

Friday's share price fall wiped out the 22 per cent gain in Infosys's shares over the past six months. That has left the outsourcer trading on 13 times forecast earnings, which is a one-third discount to TCS which trades on 19 times. But even that multiple looks rich for a company with as little visibility as Infosys.

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