Workmen prepare an electronic screen at the Infosys Ltd. popup venue ahead of the World Economic Forum (WEF) in Davos. (Photographer: Jason Alden/Bloomberg)

Why Analysts Expect Infosys To Cut Margin Forecast For Second Straight Year

Analysts expect Infosys Ltd. to lower margin guidance for the second straight year as it continues to invest in digital services, increases salaries to retain talent and hires more employees overseas.

India’s second-largest software services provider may cut its operating margin guidance to 21-23 percent for the financial year starting April, Nomura said in a research note. Motilal Oswal expects it to report margin forecast between 21.5 percent and 23 percent during the period.

Infosys projected operating margin to be in the range of 22-24 percent for the financial year ending March 2019. That’s lower than the 23-25 percent forecast in the preceding fiscal. That’s because of higher cost of training and reskilling employees as the company continues to focus on digital services like cloud computing, automation and analytics. Digital services now contribute 31.5 percent to Infosys’ revenue. Rising compensation and retention bonuses and large deal transition costs, too, put pressure on the company’s margin.

In response to BloombergQuint’s emailed query, Infosys said the company will release its guidance for financial year 2019-20 in April.

Kotak Institutional Equities, however, said Infosys expects to protect the 22-24 percent earnings before interest and taxes margin for the next financial year. Investments that counter margin growth may not continue with the same intensity and the company’s ability to leverage these investments in the ongoing financial year can help keep margin within the intended range, the research firm said citing a conversation with Infosys Chief Executive Officer and Managing Director Salil Parekh.

Also read: Q3 Results: Infosys Raises Revenue Forecast On Strong Deal Momentum

Here’s why Infosys is expected to lower its margin forecast for the next financial year:

Higher Sub-Contractor And Service Delivery Costs

Infosys’ sub-contractor expenses—the amount paid to hiring contractors—rose 39 percent on a yearly basis to Rs 4,432 crore for the nine months ended December 2018, according to the company’s filings.

Sub-contractor costs are the company’s largest expenditure after employee benefit expenses. These costs as a percentage of revenue from operations stood at 7.2 percent in the April-December 2018 period compared with 6 percent a year ago.

Sub-contracting and certain service delivery costs make up more than 40 percent of Infosys’ incremental cost of revenue, Nomura said in a note. Together they’re “depressing margin”, it said, adding the company expects sub-contracting expenses to come off only gradually. Service delivery costs will depend on collaborative contracts and the nature of packages offered to clients, it said.

Rising Employee Benefit Costs

While employee benefit expenses rose 15 percent year-on-year in rupee terms during the first nine months of the ongoing financial year, these costs as a percentage to revenue remained steady at 54.4 percent during the period, the company’s filings showed.

One-time revision in salaries to address attrition may hit margin, Nomura said. The company also continues to hire more local talent in the U.S., Europe and Australia, leading to higher employee costs. Kotak Institutional Equities said the company already has 7,500 of the planned 10,000 local headcount in the U.S.—its largest market.

Rising Sales And Marketing Costs

Infosys continues to invest in sales and marketing, and it attributes some of these spends to build brands and attract talent in the U.S. Nomura said while some of these expenses could reverse, levels of spends could remain higher than historical averages.