The Indian IT industry is going through one of the most challenging times in the last decade as sluggish global growth coupled with technology adoption impacts the industry’s growth rate.
Infosys (INFY, Financial) and Wipro (WIT, Financial) are among the technology stocks that have witnessed relatively challenging times even as these stocks are higher by 4.9% and 10.5% year to date.
With Infosys declaring results for first-quarter 2018 (quarter ended in June), this article will discuss the key numbers and whether the stock is worth buying at current levels.
While broad markets have edged higher, Infosys has remained largely sideways and with a dividend yield of 2.9%, the stock might seem appealing.
Industry headwinds remain a key challenge, though.
The challenges
One of the biggest challenges that the Indian IT industry faces is the process-oriented style of operation. The industry is going through times of massive digital disruption, and any IT company is unlikely to survive with a process-oriented approach.
An increasing trend of automation among big companies globally is a concern for the Indian IT industry as companies focus on cost cutting. The use of machines is to boost efficiency and cut costs in a sector that employs more than 3.5 million (outsourcing and lower end IT job).
Another big challenge for the Indian IT industry is an increase in protectionism in the U.S. and potentially in Europe. While the focus earlier was to reduce costs and outsource jobs, the focus has shifted to creating jobs locally to prevent rising unemployment. If this trend gains traction in the coming years, the Indian IT industry can face significant growth challenges.
I am certainly not indicating that it’s the end of the road for the Indian IT sector. In the next 12 to 24 months, there will be critical headwinds; it remains to be seen how the sector responds to these challenges.
Response to challenges
Infosys has been working on the changes in the industry in order to remain competitive.
Infosys has driven automation and innovation in its core service offering with new services in areas such as Cloud Ecosystem, Big Data and Analytics, API and Micro Services, Data and Mainframe Modernization, Cyber Security and IoT Engineering Services.
This has been done through the organic and inorganic route, but it still remains to be seen if Infosys can drive the culture of innovation among employees who have largely been restricted to process oriented work. Adoption of new technology should help Infosys retain long-term clients.
Another critical point that is worth mentioning here is that Infosys has cash and equivalents of $5.9 billion as of March 2017. In the last 12 to 18 months, the company has been active in terms of inorganic growth and the focus has been to acquire companies with emerging technology. The company’s cash glut is another key weapon in the armory, and I expect Infosys to pursue bigger acquisitions that bring disruptive technology and support the company’s growth.
Infosys has expanded its presence in China with a new campus in Shanghai. One of the key objectives of the campus is to serve as a new tech lab and an incubator for startups.
These efforts are likely to yield results in the long term, and Infosys has an edge as compared to Wipro when it comes to moving toward new technology adoption and changing the conventional process-oriented business.
Investment view
Industry headwinds coupled with challenges related to potential government regulations are the key concerns for Infosys, and the stock has underperformed year to date.
There is no doubt that the company has taken aggressive steps to counter the challenge related to innovation and in the coming quarters, efforts are likely to continue on that front.
I would still remain cautious on Infosys considering the following factors:
- First, the global markets look stretched, and so does the NASDAQ. In any case of correction in the IT index, Infosys will decline on sentiments.
- Second, there is more clarity that needs to emerge on the potential policy of Trump administration related to outsourcing.
- Third, Infosys still needs to allocate its significant cash glut toward shareholder value creation and investors will wait for answers from the management before considering fresh exposure.
Considering these points, my broad view is cautiously optimistic, but I would suggest that investors wait on the sidelines for more clarity on the points I mentioned before any exposure to the stock.
Disclosure: No positions in stocks discussed.
