Edelweiss Research - December, 24 2010- HCL Technologies

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Reduced derivative exposure may positively impact profitability

n  HCL Technologies (HCL Tech) uses hedge accounting principles for accounting of derivatives. Opening balance of derivative losses was at INR 7.8 bn, of which, INR 4.8 bn has been recognised in P&L during FY10, which is 32.5% of PBT (FY09: INR 2.4 bn; 15.2% of PBT). INR appreciation has led to MTM gains of INR 2 bn during FY10, while derivative losses of INR 1.0 bn (FY09: INR 7.8 bn) have been carried forward in reserves.

n  HCL Tech has reduced its derivative exposure from INR 38.9 bn as at FY09 end to INR 20.6 bn as at FY10 end.

n  Net un-hedged foreign currency exposure is INR 24.4 bn as at FY10 end (FY09 end: INR 20.7 bn).

Acquisitions at premium to fair value lead to substantial addition of goodwill

n  Goodwill stands at INR 35.2 bn as at FY10 end (FY09: INR 37.3 bn), at 56.0% (FY09: 75.5%) of net worth.

n  Goodwill and intangible assets for various acquisitions is higher than net consideration paid for acquisition, implying negative net tangible assets of the target companies.

Healthy operating cash flow on the back of reduced working capital requirements

n  During FY10, HCL Tech reported strong operating cash flows of INR 17.9 bn (FY09: INR 11.2 bn) on account of reduced working capital requirements. This is despite reduction in PBT from INR 16.0 bn in FY09 to INR 14.7 bn in FY10. 

n  Working capital investment has reduced from INR 5.8 bn in FY09 to INR (1.7) bn in FY10, primarily on account of increase in deferred revenue by INR 3.7 bn. Unbilled revenue stands at INR 5.3 bn as at FY10 end (FY09: INR 5.5 bn).

n  Creditors stand at INR 17.9 bn as at FY10 end (FY09: INR 20.1 bn). Average payable days at 85 days (FY09: 84 days), in our view, are high considering major operating expenses are in the form of employee expenses (51.5% of FY10 revenue).

Tax implications may affect profitability

n  HCL Tech’s effective tax rate has reduced to 14.8% in FY10 (FY09: 16.4%), primarily on account of reversal of income tax provision relating to SEZs of INR 0.3 bn and abolition of fringe benefit tax. This has resulted in increase in PAT by INR 0.6 bn (~4.6% of PAT).

n  The company may incur additional tax burden from 2012 due to expiry of the tax holiday period.

Accounting policy highlights

n  The company had issued ESOPs to its employees, which have been accounted on the intrinsic value basis. Had the company accounted the same on fair value, profit for the year would have been lower by INR 337 mn, ~2.3% of PBT.