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Margins continue to disappoint
Revenue in line, margins down 240bp QoQ
HCL Tech reported Q1 FY11 revenue of Rs36.1bn, up 5.4% QoQ with underlying
dollar revenue of US$804m, in line with our estimates. BPO revenue was up 5.7%
QoQ in dollar terms, while infrastructure services and software services grew 8.9%
and 9.3% QoQ, respectively. EBITDA margins declined 235bp QoQ, higher than
our estimate of a 140bp decline. Net profit, therefore, was lower at Rs3bn
(including ESOP charges), down 5.6% QoQ versus our estimate of Rs3.6bn.
SG&A expenses increase to historical average of 15-16%
While gross margin at 31.6% was 50bp higher than our estimate, SG&A, which
had declined to 14.3% of revenue in FY10, increased to 15.4%. This is closer to
the historical average of 15-16% (FY06-10). We expect SG&A to remain relatively
higher for the rest of FY11, which would add to margin pressure in FY11.
Margin profile needs to be reset to lower levels
We have been cautious in our outlook on HCL Tech due to our view that: a) HCL
Tech is more vulnerable to wage pressures due to a narrower employee pyramid;
and (b) steady state margins in segments such as infrastructure and BPO could be
lower than historical averages. The continued margin decline seen over the past
few quarters seems to validate our view.
Valuation: maintain Sell, expect cuts to consensus EPS
While EPS is likely to grow over 30% YoY due to lower forex losses, EBITDA
growth is likely to be only 10-11%. We expect cuts to consensus EPS post Q1
FY11 earnings as lower margins are factored in. Our price target is based on DCF.
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