>INFOSYS (CLSA)

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A renewed surge in spending after a 12m lull is rapidly improving Infosys’ order book, including new ramp ups from financial services customers and stability in other industry segments. This implies that both Infosys’ guidance and the current market consensus may prove lower than reality. Meanwhile, peer stocks have narrowed the valuation gap vs. Infosys, driving the sector towards a valuation equilibrium wherefrom Infosys shall be the first stock to break out, in our view. A 7.5-9.0% EPS upgrade for FY11-12 backs our optimism that after the multiple re-rating thus far YTD, an earnings upgrade cycle lies ahead. We are upgrading the stock from Outperform to Buy.

■ Financial services spending is returning; retail is stabilizing
Infosys’ 33% exposure to financials has been its bane in the downturn. We see clear signs of significant new business from financial services clients, including Bank of America, Barclays, Goldman Sachs, and RBS, to name a few (customer names via our channel checks, not confirmed by Infosys). Meanwhile, the beleaguered retail segment is stabilizing, even as incremental damage moderates from the ramp down at BT, now at US$50m quarterly revenue (down from its peak run rate of US$117m). Moreover, delayed vendor consolidations such as British Petroleum and LexisNexis have come to a favourable closure for Infosys.

■ Infosys’ guidance and consensus are both likely to be beaten
Infosys had guided for +1%QQ US$-revenue growth in the Sep quarter, while consensus expectations are closer to 2-3%QQ. We believe both numbers will be proven low, compared to the ramp-up beginning among Infosys’ customer base. A higher revenue throughput also implies that the extant margin guidance of down 150bpsYY for FY10 is irrelevant- we expect upside surprises on margins too.

■ What is the longer term growth trajectory?
We believe that the long term revenue growth trajectory of Indian Tech is in the low teens at best. The year past saw the sector plunge below the trend line, and FY11 could see a higher than trend growth as demand revives. Valuations are more likely to follow these swings, imparting cyclical characteristics to Indian tech stocks, including Infosys. The current phase, where earnings risks have receded and upsides seem more likely, implies upward bias on valuations as well.

■ Peer valuations have caught up sharply
Infosys has been a relatively modest performer in the last six months compared to other Indian IT stocks, after having held up better through 2008. With a sector wide valuation reset done, we see a fresh beginning to the sector’s investment case, this time anchored on earnings upsides, where we find Infosys holding out the greatest potential. The upgrade to BUY (from Outperform) makes Infosys our top sector pick with an 18% upside to our revised target price of Rs2,450.

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