Infosys' healthy and stable cash flows--with 98% revenues from repeat business--support its "modest" financial risk profile. The company's EBITDA has been consistently more than 30% despite high wage inflation in India. Its EBITDA margins are higher than most rated IT peers'.
Infosys' dependence on India-based employees exposes it to the higher country risk of India (BBB-/Negative/A-3). According to Nasscom, which represents the Indian IT and business process outsourcing industry, the rate of refusal of U.S. visas to Indians is 40% now, from less than 10% a year earlier. Delays in approvals and extensions have also increased. This can affect Infosys, which derives about 45%-50% of revenues from on-site services, which largely Indian employees provide.
Infosys' low hedging position of about US$1 billion (less than one quarter's revenues) as of Sept. 30, 2012, exposes it to fluctuations in the foreign exchange rate. The company estimates that a 1% appreciation in the Indian rupee reduces its operating margins by about 40-50 basis points. Infosys derives more than 95% of its revenues from exports, with the U.S. accounting for the majority. Indian exporters are exposed to strict regulatory requirements to remit export revenues back to India.
We expect Infosys' revenues to grow in high single-digit to low double-digits in the fiscal year ending March 31, 2013, amid uncertain demand. Nasscom estimates that the Indian IT services industry will grow faster, at 11%-14%, in the period. We expect Infosys' revenue to grow at 13%-15% in fiscal 2014. Infosys is also shifting focus on generating one-third of its revenues from service offerings (up from less than 10% in fiscal 2012) for products/platforms and solutions, in the next five to 10 years. This could lead to lower growth till these businesses stabilize.
We project Infosys' EBITDA margin at more than 31% for the next two years despite a possible weakening in prices. This is because wage inflation is likely to moderate to a high single-digit. We also expect utilization rates (excluding trainees) to stabilize at about 68%-70%. Infosys' revenue growth of 4% in dollar terms for the first half of fiscal 2013 was below our expectations; however the company managed to maintain its EBITDA margins of about 30% due to better employee utilization of 69.6%.
In our view, the Infosys management is conservative, which is reflected in its financial policies. The company has strong capital adequacy measures due to its zero external debt and minimal operating lease commitments. Infosys has avoided any large acquisitions in the past, and we expect the company to continue to maintain its financial risk profile even in case of possible acquisitions. We view Infosys' acquisition of Lodestone Holdings AG (not rated) in October 2012 for a cash consideration of US$345 million as a positive for the rating. Lodetsone provides Infosys greater access to continental European markets and the consulting business--two areas where the company has been targeting growth.
We expect Infosys' financial risk profile and business position to mitigate the risk stemming from a potential steep rise in the already high inflation in India or a sharp appreciation in the Indian rupee. This, we believe, results in a significant possibility that Infosys would be able to service its obligations even if the sovereign comes under severe stress.
Infosys' liquidity is "strong," as defined in our criteria. We expect the company's ratio of sources to uses of liquidity to exceed 1.5x over the next two years. Sources will exceed uses even if EBITDA falls by over 30%. Our assessment of the company's liquidity is based on the following factors and assumptions:
-- As of Sept. 30, 2012, the company has cash and cash equivalent of US$4.3 billion. It largely deploys surplus funds in fixed deposits with banks in India.
-- Infosys' surplus funds exceed its minimal debt-like obligations, capital expenditure, and costs for possible small to mid-sized acquisitions (including Lodestone).
-- We expect the company to generate funds from operations of more than US$1.9 billion in fiscal 2013.
-- Infosys also has strong access to capital markets in India and the U.S. Its investment-grade credit profile can also provide it strong access to banks and financial institutions.
The negative outlook reflects the outlook on the sovereign credit rating on India.
We could lower the rating on Infosys if we revise downward our transfer and convertibility assessment on India. This could be due to a downgrade of the sovereign. We could also downgrade Infosys if any of the following unlikely events occur:
-- The company makes a large acquisition or changes its financial policy, such that its credit measures deteriorate significantly. A downward trigger would be a ratio of total debt to EBITDA of more than 1.0x; or
-- Infosys has problems in project management, reputation loss, or delivery capability, and this leads to a significant loss of clients and revenues.
We could revise the rating outlook on Infosys to stable if the outlook on sovereign credit rating is revised to stable.