HCL Infosystems (Buy) – 1QFY11 results analysis : RBS

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HCL Infosystems (HCLI IN, Rs114.70, Buy) – 1QFY11 results analysis

Consolidated revenues dropped 7.7% qoq (down 1.3% yoy) to Rs29.6bn (in line with our
forecasts), driven by lower System Integration revenues (Rs1.9bn vs Rs3.7bn in 4Q10 and RBS
forecast of Rs2.0bn) and seasonally weak PC business ex-SI, down 8.9% qoq to Rs6.8bn (lower
than RBS forecast of 7.2bn). Reselling business revenues were down marginally by 0.8% qoq at
Rs20.8bn (RBS forecast was for qoq decline of 2.4%). The consolidated EBITDA margin was
down 94bp to 2.2% (we expected a 41bp dip), driven by lower SI revenues and core PC sales.
The company reported an FX gain of Rs67m (Rs52m loss in 4Q10), while the tax rate was up
461bp qoq to 34.7%. Consequently, PAT was down 29.4% qoq at Rs475m (we estimated
Rs543m ex-FX gains).
1QFY11 results – our analysis (see summary financials at end of this note)
Extent of margin decline was surprising, even after factoring in mix impact
The share of revenues from the relatively higher-margin Computer Systems (CS) business in
overall revenues was down 540bp qoq, having an impact on blended margins. Within CS, SI
revenues were down c49% to Rs1.9bn, after last quarter’s record Rs3.7bn revenues. Reported
EBIT for CS was down sharply by 41.5% qoq, despite FX gains of Rs67m (Rs52m loss in 4Q10),
indicating underlying margins were significantly weak.
Scale up and diversification of SI orders is encouraging
A doubling of SI order backlog to Rs40bn qoq came as a positive surprise, given that it stood at
Rs30bn in Sept-10 after the MP Government PDS win. Management indicated that e-governance
and financial inclusion related deal wins drove up the order backlog. Management’s comment that
~50% of the backlog has large 7- to 10-year annuity-based components should help bring more
stability in SI revenues on a medium-term basis, in our view. Core PC revenues were up a
modest 3.6% yoy, which management attributed to continuing competitive pressures in the
consumer segment.
Reselling business range-bound, shortage of new handsets could restrain volumes
We estimate that handset business revenues were flat qoq, with stable ASPs. While the success
of Nokia’s newly launched products (especially Nokia 2690) was highlighted during HCLI’s
analyst meeting in September, management said volumes were constrained due to a shortage of
newly launched handsets. We believe this could keep volumes range-bound in the near term,
while the launch of dual-sim phones should be a mid-range volume driver. Competition remains
challenging, with home-grown players at the lower end, while Android-OS based handsets are
eating away smartphone share globally.
Margin management remains the key challenge, in our view
We believe HCLI faces an uphill task in terms of stabilising margins. The overall EBITDA margin
at 2.2% is now significantly below the three-year average of 3.2%. It is in investment mode to
build out a services business (employee headcount and costs are up 16% and 24% yoy,
respectively), apart from incubating newer SI verticals and Education. We believe margins could
remain at a lower-than-normal level in the near term, although margins should improve from
current levels as SI revenues pick up.
The weak set of results could dampen sentiments on the stock in the near term. We will revisit
our forecasts given significant margin pressures.