Blogs from Our Experts | September 08, 2017
One of the key hypotheses behind Indian business growth going forward is ‘Professionalization of Indian businesses’. Professionalization is the backbone on which the thesis of ‘formalization of economy’ rests.
One of the key hypotheses behind Indian business growth going forward is ‘professionalization of Indian businesses’. Professionalization is the backbone on which the thesis of ‘formalization of economy’ rests. We have seen paint becoming a formalized industry and not remaining a commodity because large Indian Paint manufacturers like Asian Paints and Berger Paints have been professionally run for long. Indian corporate owners have realized the power of professionalization as a reward that comes with professionalization is very tangible like- higher EBITDA margin, lower inventory, lower receivables and higher market multiples. We firmly believe that this theme ‘professionalization of Indian Businesses’ is the key mega trend opportunity available in India today. We believe there will emerge multiple ‘value migration’ opportunities in various industries going forward because of this underlying theme. In fact, even when we talk about ‘value migration’ that has happened in last 10-15 years in banking space in terms of value migrating from public to private banks, it’s more about value migrating from bureaucratic set up to professional setup.
Though, recently this theme has seen some setback, first at Tata Sons and now recently at Infosys. But we hope these are those turbulent events that usually happen while a key change is in its formative years. The theme of ‘professionalization of Indian Businesses’ surely is in a formative period right now.
Under Dr. Vishal Sikka, Infosys’s financial performance was back to the industry’s top quartile, with utilization at an all-time high, attrition reduced, revenue productivity on the up and margins in a tight band. INFY’s strategy ‘renew and new’ – renewing the way of delivering existing services and also building new services of the future – resonated well with the changing landscape of technology demand. The successful execution of this strategy led to several positive output metrics, transforming INFY’s offerings, its acceptance in the market and outperformance compared to peers.
The gap in revenue growth compared to peers has converged for INFY over the last two years. In fact, INFY outperformed peers in FY16 and FY17 on an organic constant currency basis by 170bp and 75bp respectively. New services – Cloud Ecosystem, Big Data and Analytics, API and Micro Services, Data and Mainframe Modernization, Cyber Security, IoT Engineering Services – contributed to 8.3% of total revenue. New software (Edge, NIA, Panaya and Skava) and services accounted for 50% of its incremental USD 2bn revenue during recent past. At the same time, cost optimization levers have helped deliver on margins, despite pricing pressure. IT Services utilization excluding trainees is up to 84% in 1QFY18, from a mere 73% in FY13.
Though matter related to Panaya acquisition and the severance concerning Rajiv Bansal/David Kennedy have raised ire among founders particularly Mr. Narayan Murthy, we believe both Mr. Murthy and Infosys board would have exhibited more matured and professional behavior. We believe right lesson will be learnt by both promoters/founders as well as professionals from these events.
Coming to the recent market behavior, at the level of 10,000, Nifty trades at 23.5 PE on FY17 earning and 21.5 PE on FY18 expected earnings. Though investing in good quality businesses and/or improving fundamentals is key to making money through equity investing but such high valuations surely reduce the yield on investment. For trader`s too high valuation implies inferior risk-reward ratio. Also, high valuation always is preceded by either of the 3 outcomes- price correction, time correction or sharp earning growth. In this context, recently concluded Q1FY18 results do not raise hope of any sharp earning growth at least in FY18 and this leaves market dependent on the remaining 2 alternatives.
Also, Nifty all through 2017 has moved in sync with global markets and now global markets are showing signs of entering in correction and this also adds to the possibility of a correction in Nifty going forward. Recently, the perception of “risk” has been entirely eliminated from investor’s mind which never is a good sign. India and we Indians are surely on the path to a new prosperous future and there are abundant opportunities to create wealth by investing in Indian equities in structural long term sense but disregarding risk by proclaiming “this time is different” is not advisable in shorter term sense.
1QFY18 performance in a way makes the FY18 earnings recovery thesis more challenging. Nifty PAT declined 9% YoY and EBITDA declined 0.6%. Nifty EBITDA posted degrowth for the first time in nine quarters. 13 Nifty companies reported PAT above estimates, 25 below estimates, and 12 in-line. GST-related volatility will continue even in 2QFY18 before the low base of demonetization in 2HFY17 comes to the rescue. Only positive in 1QFY18 was that Nifty aggregate sales grew 8.9% YoY. Street has started FY18 estimate with 18% EPS growth but now that has got tapered to sub-15%. We think there is still room for a further cut in street estimate and we maintain our EPS growth estimate of 12%. We believe clarity on EPS upgrade, if possible, will come towards the end of September once Durga Puja and Diwali related restocking start in the trade channels. The street is still maintaining 24% growth assumption for FY19, but looking at current underlying operating metrics of various sectors, we have our doubts there as well.