Initiating report on HCL Technologies- BUY target price of Rs584: Keynote

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Initiating Coverage report on HCL Technologies Ltd.

HCL Technologies Ltd. (HCLT), incorporated in 1991, is a Gurgaon based IT and ITeS company, employing 70000+ employees, serving more than 300 clients in various industries across the globe. The company has exhibited robust 30% CAGR in operations spanning 5 years.

The company primarily focuses on software and applications alongwith Infrastructure, BPO and Engineering & R&D services and, is well known for its employee-friendly HR policies.  Following, is a brief summary of our investment thesis;

Executive Summary

Sustainability -not a concern; deserves valuation premium vis-à-vis peers

With supply-side concerns plaguing the domestic IT sector, HCLT is well-positioned to tap and retain key-talent compared to peers. The company is well known for its "Theory-Y" HR philosophy. In recent quarters, the company has established 'the talent magnet' track record and we expect similar performance, in future.

Additionally, the company has been reporting broad-based q-o-q growth across verticals. Currently the largest industry segment, Manufacturing, comprises less than 30% revenues. Accordingly, we consider the business to be well-diversified w.r.t. peers and capable of withstanding sudden changes in economic cycles.

Finally, with ~40% fixed price revenue-contribution, the company has satisfactorily addressed concerns related to long term growth.

Additional headwinds seen on package, custom-implementations fronts

Apart from the fastest growing Infrastructure (RIMS) segment, the company boasts of one of the largest SAP practice, on a global scale, metamorphosed post AXON-acquisition. Further, HCLT is well-positioned to leverage its reach, domain expertise and quality-product-portfolio to build on discretionary and transformational spends, which have gained significant industrywide-momentum during the last three quarters.

Huge scope for exercising margin levers

We see 'margin expansion'-options on the table. The management has hinted at employee-pyramid rationalisation and lower SG&A costs going forward. But, HCLT's dismal track record of operations cannot be disregarded and, concerns continue, unabated.  

Previously, during 2009-10, HCLT was aggressively cross-hiring, coupled with elevated SG&A-activity. Going forward, SG&A cost-structure will improve on account of comfortable deal position.  However, wage levers remain contingent on medium-long term growth rates.  

Valuation

At CMP HCLT's common stock is trading at 14.8x FY12E earnings. Considering the improved deal-position and robust business environment, we initiate coverage with a "buy" recommendation for target price of Rs584, arriving at 18.5x FY12E earnings for the unlevered firm.