Can Infosys Overcome Weak Services Demand?

NEW YORK (TheStreet) -- When I called for investors to sell Infosys (INFY) a couple of weeks ago, it was based on several factors.

One was the assumption that the IT services market, in which the company competes with the likes of IBM ( IBM), has started to shrink. Infosys would find it increasingly more challenging to maintain the portion of the market that it currently has.

On the heels of its earnings results for its most recent quarter, investors have begun to wonder if perhaps the company's position in the market just might be on even shakier ground than previously thought.

The Quarter That Was

The company disappointed analysts with second-quarter fiscal 2013 earnings results by missing both top and bottom line estimates. For the quarter ending Sept 28, Infosys reported net income of 75 cents per share on revenue of $1.8 billion. While the revenue total was almost a 3% improvement year over year, this fell short of estimates of $1.9 billion. Likewise, profits missed the mark of 77 cents per share.

While the earnings miss was disappointing, the overall outsourcing market has experienced considerable amount of weakness over the past several quarters. Rival IBM missed revenue estimates and Accenture ( ACN) reported per share earnings of 88 cents vs. estimates of 89 cents. On the other hand, Accenture impressed analysts by exceeding revenue projections of $7.16 billion by reporting sales of $7.29 billion.

Although Accenture saw EPS drop by over 3%, its growing sales mean it is winning in market share from Infosys, which continues to suffer from declining revenue.

Similarly, another Infosys rival, Cognizant Technology ( CTSH) seems to be doing pretty well from both EPS and revenue perspective. Cognizant recently reported an increase of 22% in net income while revenues soared 21% from the same period of a year ago.

What's more, Cognizant has averaged 28% revenue growth over the past five quarters while producing three consecutive quarters of profit growth.

These facts have not escaped current Infosys investors who have shown some signs of frustration. Also, that the most recent quarter yielded the smallest number of new customers (39) in more than a year proves investors' fear is justified.

What are investors willing to do in the meantime?

This is the essential question in the investment thesis. But analysts have become concerned that Infosys might not be able to execute effectively amid such headwinds stemming from weak IT spending.

Its earnings report in contrast to its peers suggests that not only is the company having a difficult time growing revenue, but it is a challenge that may last all the way through the second quarter of 2013. Accordingly, Infosys has had no choice but to offer a weaker outlook than expected from analysts -- trimming its net income forecasts through the first quarter of 2013 from $3.03 per share to $2.97.

Investors have found it increasingly difficult to maintain any level of confidence seeing as the company's lunch is being eaten by the competition. What's more, that Infosys is seeing its margins erode is even less comforting. But if there is anything to feel good about in terms of the company's prospects it is that the market still presents some good growth opportunities.

At some point, IT spending in the U.S. and Europe, Infosys's primary market, has to rebound and the company has as good of a shot as any to capitalize on that recovery. But then again, the competition is just not going to roll over either.

IBM, Accenture and Cognizant are all anticipating this same event. Will Infosys maintain its current strategy or look to expand beyond into emerging markets to boost revenue? Also, what will it do about its declining margins?

Bottom Line

As dire as things may appear for Infosys, I believe the company still has great management and they will overcome this near-term turbulence. In the meantime, I do like the shares at this level and I feel the stock is trading at a discount to both Accenture and Cognizant, which enjoys P/Es that are 3 and 8 points higher respectively.

For that matter, I think the recent dip in the stock presents an excellent buying opportunity for investors looking to play the IT spending rebound, which should show increased signs of recovery by Q2 2013.

At the time of publication, the author held no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Saintvilus is a private investor with an information technology and engineering background and has been investing and trading for over 15 years. He employs conservative strategies in assessing equities and appraising value while minimizing downside risk. His decisions are based in part on management, growth prospects, return on equity and price-to-earnings as well as macroeconomic factors. He is an investor who seeks opportunities whether on the long or short side and believes in changing positions as information changes.

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