infosys: what next

I noted in February about how an investor could make close to 35% on Infosys stock. All I did was pick management's target of $20 b revenues and 30% operating margins by 2020. Well, targets could not change in a month's time, could they? 

Infosys reported revenues of $10.2 b (Rs.684 b) and net income of $2.1 b (Rs.143 b) for 2017. Revenues grew 9.68% and net income 4.93% compared to last year. Management expects that revenues might grow 6.5-8.5% next year. 

To achieve the target, revenues will have to grow more than 25% annually in the next 3 years; is that possible? Of course, anything is possible. But before it becomes possible, it has to be probable, or even plausible. That's something we need to ask those who set the target. 

Yet, what seemed like a target now seems like a moonshot. If not in 3 years, when is it going to be, 5 years? Even for that to happen, revenues will have grow more than 14% annually. If revenues grow 8.5% next year as expected by management, they will have to grow close to 16% per annum in the next 4 years. Yeah, it ought to be an aspiration.

It's not wrong to aspire, though. If not 35% return, what can Infosys offer now? Let's start with keeping management's targets. Revenues of $20 and operating profits of $6 b. Assuming Infosys will continue to keep $6 b in cash earning 5% and a tax rate of 28%, its net income will be $4.5 b (Rs.317 b) whenever that happens. 

That's a net margin of more than 22%. Based on its current valuation of Rs.2,130 b, investors will be able to get an annual return of 30.80%, 43.90%, and 55% when it is priced at a PE of 15, 20, and 25 respectively in 2020. Those are returns for 3 years. If we move to a 5-year target, keeping the same pricing multiples, the expected returns will be 17.50%, 24.40%, and 30.10%. We are again back to what is plausible, probable, and possible. 

What if Infosys achieves its targets in 7 years? Then the returns would be 12.20%, 16.90%, and 20.70%. Note that these returns are not that bad. And topping these you have those juicy dividends targeted at 70% of free cash flows; they will be in excess of Rs.50 b each year. 

Even when these targets are achieved in 10 years, the expected returns based on those PE pricing will be 8.40%, 11.50%, and 14.10%. If an investor gets that 8.40% return at the lower multiple and receives a dividend yield of 2.50-3%, the aggregate returns will not look too bad. I have not included exchange rate changes in this model; investors can choose to incorporate that if they are able to. 

There is also the possibility of Infosys being priced at an earnings multiple of 10; who can rule that out? Finally, we have to ask whether this $10 b and 30% targets are achievable at all. Now, that's a question, which I will not be able to answer.