What has triggered the upside?

From a near-term perspective, the management guidance by Infosys is sending a strong signal on two fronts:

Rupee depreciation: The rupee, which had appreciated against the dollar by nearly 6 per cent in the last quarter, has reversed course during the latest quarter. This depreciation over the past quarter has been one of the factors driving the fancy for software stocks in the past quarter. Of the projected revenue increase of Rs 730 crore (from Rs 6,041 crore to Rs 6,772 crore), Rs 320 crore (explaining 44 per cent of the increase in guidance) is expected to accrue in the form of rupee depreciation.

The linkage of the rupee depreciation to per share earnings is even stronger. As a rule of thumb, let us assume that a one per cent depreciation of the rupee will have a 1.5-1.75 per cent impact on EPS. On this basis, the rupee depreciation will account for nearly 67 per cent (or Rs.4.5) of the enhanced EPS of Rs. 6.7 expected in 2004-05. Infosys' management is making a strong case for the sideways movement of the rupee during the year, although in the medium term, it expects the rupee to appreciate.

Business-led growth: Based on the rupee depreciation computation, it is obvious that 56 per cent (Rs 410 crore) and 33 per cent (Rs 2.2) of the rise in revenues and per share earnings is explained by growth in business volumes. While the revision in guidance based on rupee depreciation was expected, additional revenue growth of Rs 410 crore was a surprise. The strong growth projections for business volumes is based on four variables:

In a striking confluence of events, each of these variables has turned out to be either optimistic or less of a concern than in the past. Shareholders may consider holding their exposures, in the light of the improved earnings outlook, which appears achievable. But most of the EPS growth may only be back-ended, particularly in the third and fourth quarter of 2004-05.

Fresh exposures may, however, be contemplated only at declines as the stock has run-up since the earnings announcement and is also trading at much higher levels ex-bonus. Opportunity to buy into the stock may arise if any substantial portfolio churn happens among the frontline software stocks ahead of the Tata Consultancy Services IPO expected by this month-end.

At the same time, it is important to emphasise that practically all the medium-term challenges and risks to Infosys' financial performance remain. These are competition from multinational vendors such as IBM Global or Accenture as they scale-up operations, broadening services lines and offerings (including assessing the strength of the Infosys' consulting foray) and a possible fresh bout of billing rate pressure as clients transition their offshoring operations to a limited set of preferred frontline vendors.

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