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HCL Technologies (HCLT)
Technology
Good quarter; positives in the price. HCLT reported solid but in-line performance for
March 2011 quarter. With few headwinds, HCLT may improve margin in the June 2011
quarter though still end 320 bps lower for FY2011E. HCLT faces similar challenges on
margin protection in FY2012E—limited operational levers, weak business mix and
aggressive drive for scale. We do not share the Street’s optimism and this reflects in our
below-consensus EPS forecast of Rs30.8/Rs36.4 for FY2012/13E and TP of Rs490.
Solid but in-line 3QFY11 results
HCLT reported solid performance with sequential revenue growth of 5.8% and EBITDA margin
expansion of 110 bps. Software services revenues grew 5.4% qoq, led by volume growth of 5%.
Infrastructure services remained strong delivering 8.5% qoq. EBITDA margin expansion was driven
by (1) higher utilization rates, (2) cross-currency benefits, and (3) decline in SG&A as percentage of
revenue by 50 bps. Net income of Rs4.4 bn (+18% qoq) was 2% higher than our estimate and led
by a combination of marginal surprise at and below EBITDA line items.
4QFY11E margin expansion is known, true test is in FY2012E
HCLT, in our view, may increase margin in 4QFY11 by 100 bps; the company may have a couple of
levers in the form of utilization rate and further SG&A leverage to pull that off. However, we do
highlight that March/June quarter sequential margin analysis can be a bit misleading. Margin
comparison is more relevant on a yoy basis given the seasonality of cost movements; HCLT ended
3QFY11 with 220 bps yoy margin decline and will end FY2011E with 320 bps decline. The true
test of protecting profitability without sacrificing growth will be in FY2012E, where HCLT will have
to contend with limited visible levers (high utilization rates, low SG&A as percentage of revenues)
and weak business mix. Clearly, we are not as sanguine as the rest of the Street and this reflects in
our below-consensus EPS of Rs30.8 and Rs36.4 for FY2012E and FY2013E, respectively.
Relative valuation expensive in light of inferior FCF profile
Adjusting net income to March fiscal year-end, HCLT trades at 18X FY2012E and 15X FY2013E
earnings. Contrary to the Street, we do not find HCLT inexpensive relative to larger peers. Even as
the PE discount to TCS at ~20% on consensus estimates may appear attractive to some, we note
that the discount on EV/FCF (we use EV and not market cap to adjust for differences in excess cash)
for HCLT versus TCS is just 5%. We believe that the margin and working capital management
differential between the two companies (which will inevitably lead to inferior FCF/EBITDA profile
for HCLT) demands a 35-40% PE discount – this is based on assumption of identical growth rates
for both the companies. Our target price of Rs490 is based on 14X FY2013E earnings, a 35%
discount to our target multiple for the sector leader, TCS.
Highlights from 3QFY11 results announcement/ management commentary
Revenue growth was aided to the extent of 100 bps on favorable cross currency
movement
Revenue growth was led by IT services, which grew 6.2% qoq. Software services grew
5.4% qoq to US$651 mn led by volume growth of 4.9% and the balance through cross
currency changes. Infrastructure services revenues grew 8.6% qoq to US$214 mn
BPO revenues were flat. BPO reported EBITDA loss of US$1.6 mn. Contribution from BPO
segment has declined to 5.4% to revenues from 11.7% two years back
Revenues from the ROW geography grew 21.4% qoq and contributed to 60% of
incremental revenues. Financial services revenues grew 13% qoq
Net hiring was a weak 1,153, impacted a headcount decline of 464 in the BPO segment.
IT services hiring at 1,617 was also modest for the quarter
Offshore utilization rates in the IT services business increased 180 bps qoq. Utilization rate
in infrastructure growth would have also improved given the large gap in sequential
revenue growth and net hiring
Client metrics were steady—number of US$50 mn customers increased by 1, US$20 mn
by 3. However, revenue contribution from top 5, 10 and 20 customers declined further
reflecting modest growth in large accounts
Hedges outstanding were nearly flat qoq at US$265 mn
The company acquired software assets from Citibank in a carve-out for a consideration of
US$26 mn to be paid in two tranches of US$13 mn each, one already paid and the other
to be paid at end-March 2012. The carve-out comes with assured revenues of US$135
mn over the next 10 years with revenue flow starting in mid-June 2011 quarter.
Some benefit of doubt given on margins; raise earnings and target price
We raise our FY2012E and FY2013E EPS estimates by 4.3% and 6.8% to Rs30.8 and Rs36.4,
respectively led by (1) a modest 1% increase in our revenue assumption for both the years,
(2) 40 bps and 60 bps upgrade in our operating margin assumption, and (3) below EBITDA
line adjustments viz lower depreciation and RSU charge. We have given some benefit of
doubt on potential S&M leverage and assumed that utilization rate can be sustained at
elevated levels. We raise our target price to Rs490 from Rs440 earlier. Our target price is
based on 15X FY2013E earnings normalized for March fiscal year-end and builds in 35%
discount to the sector leader. Maintain REDUCE rating.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
HCL Technologies (HCLT)
Technology
Good quarter; positives in the price. HCLT reported solid but in-line performance for
March 2011 quarter. With few headwinds, HCLT may improve margin in the June 2011
quarter though still end 320 bps lower for FY2011E. HCLT faces similar challenges on
margin protection in FY2012E—limited operational levers, weak business mix and
aggressive drive for scale. We do not share the Street’s optimism and this reflects in our
below-consensus EPS forecast of Rs30.8/Rs36.4 for FY2012/13E and TP of Rs490.
Solid but in-line 3QFY11 results
HCLT reported solid performance with sequential revenue growth of 5.8% and EBITDA margin
expansion of 110 bps. Software services revenues grew 5.4% qoq, led by volume growth of 5%.
Infrastructure services remained strong delivering 8.5% qoq. EBITDA margin expansion was driven
by (1) higher utilization rates, (2) cross-currency benefits, and (3) decline in SG&A as percentage of
revenue by 50 bps. Net income of Rs4.4 bn (+18% qoq) was 2% higher than our estimate and led
by a combination of marginal surprise at and below EBITDA line items.
4QFY11E margin expansion is known, true test is in FY2012E
HCLT, in our view, may increase margin in 4QFY11 by 100 bps; the company may have a couple of
levers in the form of utilization rate and further SG&A leverage to pull that off. However, we do
highlight that March/June quarter sequential margin analysis can be a bit misleading. Margin
comparison is more relevant on a yoy basis given the seasonality of cost movements; HCLT ended
3QFY11 with 220 bps yoy margin decline and will end FY2011E with 320 bps decline. The true
test of protecting profitability without sacrificing growth will be in FY2012E, where HCLT will have
to contend with limited visible levers (high utilization rates, low SG&A as percentage of revenues)
and weak business mix. Clearly, we are not as sanguine as the rest of the Street and this reflects in
our below-consensus EPS of Rs30.8 and Rs36.4 for FY2012E and FY2013E, respectively.
Relative valuation expensive in light of inferior FCF profile
Adjusting net income to March fiscal year-end, HCLT trades at 18X FY2012E and 15X FY2013E
earnings. Contrary to the Street, we do not find HCLT inexpensive relative to larger peers. Even as
the PE discount to TCS at ~20% on consensus estimates may appear attractive to some, we note
that the discount on EV/FCF (we use EV and not market cap to adjust for differences in excess cash)
for HCLT versus TCS is just 5%. We believe that the margin and working capital management
differential between the two companies (which will inevitably lead to inferior FCF/EBITDA profile
for HCLT) demands a 35-40% PE discount – this is based on assumption of identical growth rates
for both the companies. Our target price of Rs490 is based on 14X FY2013E earnings, a 35%
discount to our target multiple for the sector leader, TCS.
Highlights from 3QFY11 results announcement/ management commentary
Revenue growth was aided to the extent of 100 bps on favorable cross currency
movement
Revenue growth was led by IT services, which grew 6.2% qoq. Software services grew
5.4% qoq to US$651 mn led by volume growth of 4.9% and the balance through cross
currency changes. Infrastructure services revenues grew 8.6% qoq to US$214 mn
BPO revenues were flat. BPO reported EBITDA loss of US$1.6 mn. Contribution from BPO
segment has declined to 5.4% to revenues from 11.7% two years back
Revenues from the ROW geography grew 21.4% qoq and contributed to 60% of
incremental revenues. Financial services revenues grew 13% qoq
Net hiring was a weak 1,153, impacted a headcount decline of 464 in the BPO segment.
IT services hiring at 1,617 was also modest for the quarter
Offshore utilization rates in the IT services business increased 180 bps qoq. Utilization rate
in infrastructure growth would have also improved given the large gap in sequential
revenue growth and net hiring
Client metrics were steady—number of US$50 mn customers increased by 1, US$20 mn
by 3. However, revenue contribution from top 5, 10 and 20 customers declined further
reflecting modest growth in large accounts
Hedges outstanding were nearly flat qoq at US$265 mn
The company acquired software assets from Citibank in a carve-out for a consideration of
US$26 mn to be paid in two tranches of US$13 mn each, one already paid and the other
to be paid at end-March 2012. The carve-out comes with assured revenues of US$135
mn over the next 10 years with revenue flow starting in mid-June 2011 quarter.
Some benefit of doubt given on margins; raise earnings and target price
We raise our FY2012E and FY2013E EPS estimates by 4.3% and 6.8% to Rs30.8 and Rs36.4,
respectively led by (1) a modest 1% increase in our revenue assumption for both the years,
(2) 40 bps and 60 bps upgrade in our operating margin assumption, and (3) below EBITDA
line adjustments viz lower depreciation and RSU charge. We have given some benefit of
doubt on potential S&M leverage and assumed that utilization rate can be sustained at
elevated levels. We raise our target price to Rs490 from Rs440 earlier. Our target price is
based on 15X FY2013E earnings normalized for March fiscal year-end and builds in 35%
discount to the sector leader. Maintain REDUCE rating.
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