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HCL Technologies -2QFY11 results
Credit is due to the HCL management for managing street’s expectations
very well. What else explains the street’s clamour for a valuation rerating
at HCL? Financial performance clearly does not back-up re-rating
claims. We note the following points: 1) Ebitda has now remained flattish
for the past 7 quarters, even as revenues are up over 30%. 2) HCL Tech
is the only stock among top tier Indian tech where FY11 consensus
earnings have been cut through 2010. 3) FY12 consensus earnings have
seen the least upgrades (through 2010) at HCL Tech among Tier-1 peers.
4) Ask-rate to meet FY12 Ebitda numbers remains the highest at HCL
among Tier-1 peers. In our view, the street is giving a long rope to HCL,
awarding a higher PE on elevated earnings. We remain cautious.
Good revenue growth was the sole bright spot in the quarter
Revenue growth of 7.5%QQ was the only bright spot in what was another
unconvincing quarter from HCL on the margin front. We remain surprised by
the scale of margin deterioration at HCL through the past few quarters amid a
strong demand environment. Margins in the core IT Services segment are
down ~700bps from recent peak in the Sep-09 quarter. We question HCL's
hypothesis that increased lateral hiring/SG&A investment is driving this downtick.
Peers Infosys and TCS have been equally active on lateral hiring without
taking any margin hit and HCL’s gross margins (in core IT) have also taken a
substantial hit (down 520bps over Sep-09) driven by aggressive pricing on
deals. Moreover, HCL’s pricing performance (constant currency terms) was
also subdued in the quarter, even as peers reported pricing increases.
Not excited about prospects of margin improvement thru 2HFY11
HCL expects to recover ~200bps in margins through the next two quarters.
HCLT may win back margins in Mar-Jun quarters (hopefully, and already built
in street estimates), but a new round of wage hikes will start from 1st July
derailing the margin progress. Moreover, the key to stock performance
remains maintaining the revenue trajectory (in-line with Tier-1 peers) while
recovering margins and not trading one for the other. We also remain
unhappy by the cash flow profile at HCL Tech. Free cash flow at ~30% of
profits is much lower than peers Infosys and TCS, who are at ~70-75%.
Inferior financials warrant material PE discount to Tier-1 peers
HCL's PE discount to Tier-1 peers is driven primarily by the volatility in its
financial performance and the past few quarters have done little to allay those
concerns. While revenue growth has been strong, it has come at the expense
of margins precluding earnings upgrade prospects. In our view, HCL needs to
show more proof points on margin recovery while maintaining revenue
growth to deserve a re-rating. Till then, Underperform stays.
Clamour for HCL’s re-rating is unjustified
We see a big section of the street arguing for a re-rating for HCL. We fail to
understand the street’s desire to re-rate given HCL’s inferior financial
performance not just compared to peers Infosys/TCS but also c.f. street’s own
expectations. In our view, this cry for re-rating is not adequately backed by
financial performance. Picture this:
Growth without profits: While HCL has undoubtedly been a growth leader
through the last few quarters, sharp dip in profitability has meant that the
growth has not translated into profits. See Figures 3 & 4.
Inferior quality of profits: Not only has HCL trailed peers in profitability
metrics, quality of earnings has also been inferior. Conversion of net profits to
free cash flow has been much lower than peers Infosys/TCS. See Figure 5.
FY11 consensus earnings cut through 2010: HCL Tech is the only stock
among top tier Indian techs where FY11 consensus earnings have been cut
through 2010, even as peers have seen upgrades. See Figure 6.
Lowest upgrades on FY12 earnings: Compared to Infosys and TCS, who
have seen 10% and 25% upgrade on FY12 earnings through 2010, HCL has
seen just 5% earnings upgrades. HCL has clearly trailed the upgrade cycle.
High ask-rate to meet consensus estimates c.f. peers
Ask-rate to meet consensus Ebitda estimates at HCL remains much higher c.f.
Infosys and TCS. Street expectations centre on HCL maintaining its current
revenue trajectory while improving margins. We would remain wary of this
bullish expectation and HCL’s past history does not extract a benefit of doubt
on this front as well.
India Equity Research Reports, IPO and Stock News Visit http://indiaer.blogspot.com/ for complete details �� ��
HCL Technologies -2QFY11 results
Credit is due to the HCL management for managing street’s expectations
very well. What else explains the street’s clamour for a valuation rerating
at HCL? Financial performance clearly does not back-up re-rating
claims. We note the following points: 1) Ebitda has now remained flattish
for the past 7 quarters, even as revenues are up over 30%. 2) HCL Tech
is the only stock among top tier Indian tech where FY11 consensus
earnings have been cut through 2010. 3) FY12 consensus earnings have
seen the least upgrades (through 2010) at HCL Tech among Tier-1 peers.
4) Ask-rate to meet FY12 Ebitda numbers remains the highest at HCL
among Tier-1 peers. In our view, the street is giving a long rope to HCL,
awarding a higher PE on elevated earnings. We remain cautious.
Good revenue growth was the sole bright spot in the quarter
Revenue growth of 7.5%QQ was the only bright spot in what was another
unconvincing quarter from HCL on the margin front. We remain surprised by
the scale of margin deterioration at HCL through the past few quarters amid a
strong demand environment. Margins in the core IT Services segment are
down ~700bps from recent peak in the Sep-09 quarter. We question HCL's
hypothesis that increased lateral hiring/SG&A investment is driving this downtick.
Peers Infosys and TCS have been equally active on lateral hiring without
taking any margin hit and HCL’s gross margins (in core IT) have also taken a
substantial hit (down 520bps over Sep-09) driven by aggressive pricing on
deals. Moreover, HCL’s pricing performance (constant currency terms) was
also subdued in the quarter, even as peers reported pricing increases.
Not excited about prospects of margin improvement thru 2HFY11
HCL expects to recover ~200bps in margins through the next two quarters.
HCLT may win back margins in Mar-Jun quarters (hopefully, and already built
in street estimates), but a new round of wage hikes will start from 1st July
derailing the margin progress. Moreover, the key to stock performance
remains maintaining the revenue trajectory (in-line with Tier-1 peers) while
recovering margins and not trading one for the other. We also remain
unhappy by the cash flow profile at HCL Tech. Free cash flow at ~30% of
profits is much lower than peers Infosys and TCS, who are at ~70-75%.
Inferior financials warrant material PE discount to Tier-1 peers
HCL's PE discount to Tier-1 peers is driven primarily by the volatility in its
financial performance and the past few quarters have done little to allay those
concerns. While revenue growth has been strong, it has come at the expense
of margins precluding earnings upgrade prospects. In our view, HCL needs to
show more proof points on margin recovery while maintaining revenue
growth to deserve a re-rating. Till then, Underperform stays.
Clamour for HCL’s re-rating is unjustified
We see a big section of the street arguing for a re-rating for HCL. We fail to
understand the street’s desire to re-rate given HCL’s inferior financial
performance not just compared to peers Infosys/TCS but also c.f. street’s own
expectations. In our view, this cry for re-rating is not adequately backed by
financial performance. Picture this:
Growth without profits: While HCL has undoubtedly been a growth leader
through the last few quarters, sharp dip in profitability has meant that the
growth has not translated into profits. See Figures 3 & 4.
Inferior quality of profits: Not only has HCL trailed peers in profitability
metrics, quality of earnings has also been inferior. Conversion of net profits to
free cash flow has been much lower than peers Infosys/TCS. See Figure 5.
FY11 consensus earnings cut through 2010: HCL Tech is the only stock
among top tier Indian techs where FY11 consensus earnings have been cut
through 2010, even as peers have seen upgrades. See Figure 6.
Lowest upgrades on FY12 earnings: Compared to Infosys and TCS, who
have seen 10% and 25% upgrade on FY12 earnings through 2010, HCL has
seen just 5% earnings upgrades. HCL has clearly trailed the upgrade cycle.
High ask-rate to meet consensus estimates c.f. peers
Ask-rate to meet consensus Ebitda estimates at HCL remains much higher c.f.
Infosys and TCS. Street expectations centre on HCL maintaining its current
revenue trajectory while improving margins. We would remain wary of this
bullish expectation and HCL’s past history does not extract a benefit of doubt
on this front as well.
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