AFTER UBS DOWNGRADE, WHAT DO WE DO?

By Ruma Dubey

Yesterday, Infosys had lost a lot of ground. All of a sudden, in the morning, the stock was streaked deep red. The CNX IT index declined more than 2.5% yesterday, its lowest level in five months, led by Infosys, which fell more than 3.15%, its biggest single-day fall in nearly a month. There was neither any new report of any top management leaving the company nor was there was any untoward operational news from the company, like losing a client or slashing its rates further.

Scrambling for reason, one came across the UBS report on Infosys, which was later splashed all across the media. UBS, one of the largest FIIs in India, had put out an extremely negative, hard hitting report on the company’s future outlook. More than the outlook, what had really upset the market was that UBS, which was earlier a big “BUY” on the counter, put out an outright “SELL” and more importantly, slashed the target price from the earlier Rs.4050 to Rs.2750, a straight cut of over 32%. Now this is indeed sharp and pretty dramatic; we do not see such kind of aggressive “sell” unless some major calamity has befallen the company. And that made us wonder what had indeed prompted the FII to go so aggressive?

We read through the report prepared by their analyst Diviya Nagarajan and presented below is a synopsis of its reasons for the downgrade.

• A turnaround at the IT outsourcer could take longer than expected
• The next wave in the IT sector which will lead earnings will be infrastructure services and BPO but here, Infosys lags behind as currently less than 15% of its revenue comes from this “growth wave”. On the other hand, HCL Tech and TCS are better equipped to catch this wave as they both are already earning around 25-30% of their revenue from infra services and BPO.
• Currently 85% of Infosys revenue comes from Business application services and this could weigh down the revenue as the company itself has indicated that jump starting growth from this level might prove to be difficult.
• The high attrition rate, amongst the highest in the sector, at Infosys is worrisome where in FY14, the company lost nearly one fourth of its FY13 employee base. This means that even if demand perks up, attrition will restrict Infosys ability to translate that into higher revenue and margin growth.
• TCS on the other hand, has given much sharper wage hikes, more than Infosys and that too is expected to go against Infosys.
• UBS is concerned about the leadership churn at the top and sounding extremely dramatic, the report has stated that Infosys is at a high risk of becoming a fractured organization if this leak at the top and of employees is not plugged soon. Once a new CEO is appointed, UBS expects more churning.
• Infosys has not been able to curtail loss of market share with key clients which is affecting growth and improvement in demand.

The report, as one can see, does not mince any words and actually puts out points which truly worries people like you and me. So are we now saying here that Infosys as a story is over?  Are we relying too much on Narayana Murthy having the ability to bring it back to its glorious days?

Well, that would indeed be too drastic. When Narayana Murthy came back, the first thing he said was the it would take around three years for the company to turnaround; this he had said in June 2013 and that means we have 24 more months to go and this is exactly what UBS has also said - will take longer than expected to turnaround. Murthy had also said then that Infosys had lost focus on its core strategy – which was business outsourcing and during these months, planned to get back onto this growth engine. He was ready for flexible pricing, willing to sacrifice margins to revive revenue growth.

In a way, UBS has put in facts and figures, what Murthy already told us when he took over. Yes, there is trouble at Infosys and it has relinquished its bellwether position to TCS. But our view is that this is for a short time; in the long run, say 3- 4 years down the line, Infosys will reinvent itself. The immediate short term outlook is not too good and we will have to monitor it quarter to quarter. But to sell the stock, lock-stock-and barrel, would be unnecessary.

Interestingly, out of 63 FIIs tracking the stocks, only four have put out this ‘sell’ call; in fact majority of them, after the Q4 numbers have put out a ‘buy’ or ‘hold’.  

This is a worldwide phenomenon where brokerage houses constantly publish upgrades and downgrades. And all over, they are eyed with a lot of suspicion. They are always blamed, like we do here, of having vested interests while putting out these reports. They surely might have vested interests in most of the reports but it is up to us as to how we treat this information.

Maybe if you have conviction in a stock, when the rating downgrade pushes the stock price down, it could be the best time to actually go contrarian and buy. Thus it is our decision entirely about how much importance we give to these reports. Brokerages houses, be it domestic or international, are ultimately about making money and all their actions will be about maximizing their returns. We too need to do the same and stop being a cow in a herd.