HCL Technologies: Mixed Sept ‘10 with strong revenue growth:: Morgan Stanley

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HCL Technologies: Mixed Sept ‘10 with strong revenue growth but muted margin performance
Quick Comment: HCLT reported mixed Sept. ‘10
results. Strong 9% QoQ revenue growth was better than
our and Street expectations. However, margins in IT
services business declined -300bps QoQ due to wage
hikes and higher sales and marketing investments.
Overall net income of Rs3.1bn (-2.8% QoQ, +2.9% YoY)
was in line with our expectations.
Revenue growth across segments: Software services
and infrastructure services revenue grew at 9% QoQ
each. BPO revenue surprised positively with 5.7% QoQ
revenue growth. Strong growth was driven by Europe
(14% QoQ) and Asia Pacific (20% QoQ), while revenue
growth in US (~58% of revenue) slowed to 2.8% QoQ.
Strong revenue growth in Europe and retail was in line
with the growth trends for Infosys.
Management guided for 250bps YoY margin decline
for FY11e excluding currency. At current levels, the
rupee has appreciated by ~5% in FY11e and could
further impact margins by 100-150bps. HCLT increased
its sales force by 13% QoQ. Management indicated that
for 2Q, SG&A expenses are expected to increase further
to 16% of revenue (+60bps QoQ) but it expects flattish
QoQ margins in 2Q.
Financials: We expect HCLT to grow US$ revenue by
25% in FY11e with 15% EBIT growth. Lower FX losses
should help EPS growth of 44% in FY11e and 20% EPS
CAGR from F2011-13e. Given the weak profitability
trends, stronger YoY revenue growth should not
materially alter our earnings forecasts. HCLT stock has
run-up 15% over the last month, while outperforming the
market. On the back of margin weakness in 1Q and
muted FY outlook, we believe it could give up some of its
recent gains.