Infosys Must Overcome Margin Pressure

NEW YORK (TheStreet) -- Given the weaker-than-expected results we've seen in hardware and software companies such as Oracle (ORCL) and Cisco  (CSCO), there's no question that robust IT enterprise spending still remains "right around the corner." And this constant waiting game makes it increasingly difficult to value companies like Infosys (INFY) that rely on an even weaker spending environment in IT consulting.

Fearing that this industry is still ways away from returning to its once-robust levels, the Street has already punished larger rivals like IBM  (IBM) and to a lesser extent Accenture  (ACN). While I've always believed in this industry, my concern is that Infosys, despite being better managed, would find it increasingly challenging to maintain the portion of the market that it currently has.

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On Friday,Infosys will report its first quarter results. Although the Street seems a bit more optimistic, with projections of 9.2% revenue growth, it's hard for me to get excited about the company's earnings projections, expected to be a penny lower than last year. And I have to believe that the company's margins might be a big reason for the expected decline.

We can always blame macro weakness for any downbeat results in the overall consulting space. But Infosys management has made some questionable decisions that has caused me to rethink the company's prospects. Perhaps the company's market position might not be as strong as the Street believes it to be.

For instance, unlike Accenture and Cognizant (CTSH), Infosys management have been more "reactive" than proactive. I don't believe the company has responded quickly or adequately enough to the changing market. Plus, I believe their failure to unhinge the company from the discretionary spending environment, which is always in flux, has set the company back against both Accenture and Cognizant.

The good news is that the market still presents some good growth opportunities. And management has recently spoken about investments that the company has made to get Infosys back on track. Even so, I have to wonder if/when IT consulting spending does return to robust levels, is Infosys positioned well enough to exploit service outsourcing? At least not to the extent of its better-prepared rivals.

While I've always liked the company's potential, at some point that potential needs to manifest itself in meaningful results. It's hard to feel good about a business that always seems to be under pricing pressure, particularly on the IT side of the operation. And this has occurred even amid some near-term "moderate" growth in global demand.

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Some might say I'm being too harsh. But even if I wanted to see the bright side of things, in the company's above-average revenue growth, for example. But I've never believed Infosys posted strong enough profitability even during its best quarterly revenue performances. This goes back to what I've cited above regarding the company's underwhelming margin performances.

To the extent that Infosys management can fix the margin situation and develop any sort of leverage, the stock can work. But that's a big "if." And while IT spending in the U.S. and across the globe will rebound, management should also look to expand into emerging markets not only to boost revenue, but to begin to pave the way for more pricing leverage and free cash flow growth.

In other words, while the top line has been impressive, it has meant very little to nothing at all to shareholders in terms of profits. And this quarter is expected to be no different. What makes this even tougher is that the stock price remains very attractive relative to shares of Cognizant and Accenture. I just don't have the confidence at this point to buy it with my own money.

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

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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