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HCL-Technologies Overweight
HCLT.BO, HCLT IN
Impressive revenue growth with good margin
expansion; reiterate OW though stock uptick overdone
• HCLT demonstrated a TCS-like performance in 3QFY11 (Mar-11 quarter)
for the first time in recent times. It tightened operations and impressively
improved margins while also growing revenues (+5.8% Q/Q to USD 915 mn).
Further, HCLT has also stated its confidence for further margin improvement in
the next quarter (4QFY11). However, this must be sustained for re-rating of the
stock. That said, the signs are encouraging and we reiterate OW.
• Stock price up-tick (up 10%) perhaps a bit overdone largely reflecting a
relief trade. The quarter (3QFY11) saw HCLT meet our expectations and those
of consensus, not materially beat them. The up-tick of the stock (up 10%
yesterday) seems overdone which we put down to a relief trade in view of the
prior anxiety among the buy-side created by the disappointing Infosys results.
• Highlights included improved margins and enhanced client mining metrics.
The count of USD 30 mn+ clients almost doubled on a LTM basis (from 10 in
3QFY10 to 19 in 3QFY11) suggesting that HCLT is improving and executing
on its multi-service positioning (apps + infra management). Also, we think
margin performance will alleviate the street’s primary concern with regard to
HCLT (EBIT margins up 130 bps Q/Q (pre ESOP costs)).
• Quarter specifics. Industry-wise, BFSI (top-line growth of 12.6% Q/Q) drove
revenue growth. Energy, Utilities and public sector (+7.1% Q/Q) and
Manufacturing (+6.3% Q/Q) also registered healthy revenue growth, while
other verticals witnessed modest growth. Telecom (+0.9%) is the only soft spot,
which we believe is indicative of spending pressures in the industry. Revenue
growth was driven by Infrastructure Services, Custom Application Services and
Enterprise Application Services, which grew 8.5%, 6.7% and 6.7% Q/Q. The
traction in HCLT’s enterprise application services is particularly pleasing as this
is the higher-value revenue stream that HCLT needs to ramp up following its
acquisition of AXON effective Dec 2008. BPO revenues were flat.
• Another positive coming out of the quarter was a decrease in HCLT’s attrition
(quarterly annualized attrition decreased to 17.7% for IT Services from 21.9% in
1QFY11). We believe the decline in attrition that we have observed in company
results so far (Infosys and Persistent also reported decline in attrition) should
reduce supply-side related pressures for the industry. Wage hikes are likely to be
more moderate in FY12 versus FY11 – a beneficial outcome for the industry.
• We reiterate our OW rating on the stock. We retain our Mar-12 price
target of Rs 560. Our estimates remain largely unchanged for FY12/13
Impressive margin expansion along with
strong revenue growth is commendable
HCLT reported EBIT margin (pre ESOP costs) expansion of 130 bps from 13.1% in
2QFY11 to 14.4%, and posted revenue growth of 5.8% in 3QFY11, which we
believe is impressive. Management had committed to focus on improving margins
and has delivered on this commitment. HCLT has exhibited revenue growth at a
CQGR of 7.3% over the last 4 quarters, which is commendable, but margin
deterioration in 1QFY11 was concerning and re-orientation towards margins should
alleviate some of these concerns. We believe the company is on track to achieve
its EBIT margin target of 15.3% (pre ESOP costs) in 4QFY11.
Tightening operations while still growing revenues is something which, except
TCS, no other company has been able to accomplish recently. It exhibits the
effectiveness of internal and external focus of the company. However, HCLT
needs to continue tightening its cost structure to improve margins for at least 2-
3 more quarters to build confidence in management's ability to control/manage
margins effectively.
Moreover, margin expansion was broad-based as Software and Infrastructure
Services, both registered margin expansion of 120 bps, while BPO EBIT loss has
also declined from 10.9% to 9.2%. Gross margin improvement and SG&A efficiency
drove the margin expansion. Gross margins improved 80 bps from 28.4% in 2QFY11
to 29.2% in 3QFY11, while SG&A as a % of sales declined from 15.2% to 14.7%.
Higher utilization and exchange rate benefits contributed to the gross margin
expansion. SG&A as a % of sales peaked at 15.4% in 1QFY11 and we expect this
ratio to continue declining in 4QFY11, before increasing in 1QFY12.
Revenue growth was broad-based and
convincing
HCLT reported strong and broad based revenue growth. All the verticals, service
lines and geographies reported positive revenue growth in 3QFY11. The company
has registered 7.3% CQGR over the last four quarters; hence fairly consistent
revenue growth performance. HCLT witnessed impressive Q/Q revenue growth in
BFSI (+12.6%), Energy, Utilities and Public sector (+7.1%) and Manufacturing
(+6.3%) verticals, while Healthcare, Retail, Telecom and other verticals’ growth was
soft but positive. Noticeably, CQGR in the last four quarters for Retail (+11.4%),
Healthcare (+9.5%) and Telecom (+4.4%) has been strong.
In terms of service lines, Infrastructure Services (+8.5%), Custom Applications
(+6.7%) and Enterprise Application Services (+6.7%) experienced mid to high single
digit growth rate. BPO growth was light but the business is going through
restructuring currently and the sale of certain accounts to Tangoe also impacted the
top-line by $3.6 mn. By geography, ROW drove the growth with 21.7% Q/Q
increase, while Europe revenues grew 7.3% as the company is experiencing revenue
traction in Continental Europe. Revenues from Americas grew only 0.7% during the
quarter, which we believe is the only concerning point of the quarter. However
Americas’ revenues have grown at a CQGR of 5.1% over the last four quarter, which
is healthy, if not strong in our view.
Improved client mining addresses some of the concerns we earlier identified in
our report “A progressive approach so far but work still lies ahead” (dated Dec.
10,2010). The multi-service positioning (apps + infra management) has started
to pay off and HCLT is seemingly able to cross-sell and up-sell its offerings. The
increase in $30 mn accounts from 10 in 3QFY10 to 19 in3QFY11 substantiates
HCLT’s ability to mine large clients effectively.
3QFY11 Highlights
• Revenues came in at $915 million, up 5.8% Q/Q and at Rs.41.4 billion in rupee
terms, up 5.6% from 2QFY11. Revenues grew 4.8% in constant currency terms,
primarily driven by volumes growth, while pricing was almost flat.
• Infrastructure Services (up 8.5% Q/Q in $ terms) and Software Services (+5.4%)
drove the revenue growth, while BPO continued to lag as top-line growth
moderated to 0.8% from 2.9% in 2QFY11 and 5.7% in 1QFY11. Notably, the
soft growth in BPO was because of the sale of certain Telecom Expense
Management accounts to Tangoe, a leading company in TEM space. These
accounts had quarterly run rate of $3.6 mn, including which BPO revenues
would have grown about 8%.
Table 2: Q3FY11 Quarterly Revenue growth drivers
Factor Impact
Volume 4.8%
Cross-currency tailwind 1.0%
US$ Revenue growth 5.8%
Source: Company reports and J.P. Morgan estimates.
• EBIT margins increased to 13.9% (post ESOP costs) in 3QFY11, an expansion
of 140 bps from 12.5% in 2QFY11. Improved gross margins (up 80 bps from
27.7% to 28.6%) and SG&A efficiency (50 bps impact) drove the margin
expansion. Notably, low margins are the primary concern about this
company and strong margin expansion this quarter suggests that
management is working towards alleviating these concerns.
• We estimate that Software services, which contributes more than 70% of the
total company revenues, witnessed pricing increase of 0.5% Q/Q as both onsite
(+1.1%) and offshore (+1.5%) pricing registered modest up-ticks. Volumes for
Software Services increased 4.9% Q/Q primarily driven by offshore volumes
(+5.6%), while onsite volumes were (+3.0%) up as well.
• Utilization (including trainees) for Software Services increased from 75.7% in
2QFY11 to 77.3%, as onsite utilization was up from 95.9% to 96.5% and
offshore utilization (including trainees) increased from 70.1% to 71.9%.
Utilization excluding trainees was up 120 bps from 79.8% to 80.9% in 2QFY11.
Offsite utilization ex trainees increased from 75.0% to 76.3%.
• HCLT’s new client additions continue to be robust as the company added
58 clients in the last four quarters. On LTM basis, net increase in million
dollar clients was 12, compared to 20 in 2QfY11 and 9 in 1QFY11.
• Financial services revenues grew double digit registering 12.6% Q/Q increase
(10.5% in constant currency (CC) terms). Energy, Utilities and Public Sector and
Manufacturing also witnessed healthy growth of 7.1% Q/Q and 6.3% Q/Q (6.3%
and 6.1% in CC terms), respectively. Media Publishing and Entertainment
(+2.3%) and Healthcare (+1.2%) grew modestly. Telecom and Retail verticals
were broadly flat with nominal increase on reported basis but slight decline on
constant currency basis. Weakness in Telecom points to continued spending
pressures in the industry.
• By business lines, Infrastructure Services registered strong growth of 8.5%.
Custom Application Services and Enterprise Application Services both grew
6.7% each. Engineering and R&D Services growth was light at 1.3%, while
BPO revenues were almost flat primarily because of sale of certain client
accounts to Tangoe.
• On LTM basis, revenues from the top 10 clients were up 4.2% Q/Q. Revenue
growth from top 20 clients was 4.7%. Non-top 20 clients grew at a higher rate
than top 20 clients.
• Proportion of fixed price contracts increased 50 bps from last quarter to 42.0%.
It has increased 150 bps y/y.
• HCLT reported net addition of 1,153 employees during the quarter, moderating
from 2,049 in 2QFY11 and 5,661 in 1QFY11. Software Services saw net
addition of 867 employees and gross addition of 2,939 people, while
Infrastructure Services’ net addition was 750 people and gross addition was
1,468 employees. BPO headcount continued to decrease (-464) despite hiring
3,127 employees as attrition continues to be very high. The gross hiring for the
quarter stood at 7,534.
• Quarterly annualized attrition for Software Services decreased modestly to
17.7% from 18.1% in 2QFY11. Infrastructure Services’ quarterly annualized
attrition was flat at 20.5%, hence consolidated IT Services’ attrition level
decreased from 18.6% to 18.3%. BPO continues to witness very high quarterly
attrition of 11.0%, slightly up from 10.8% in 2QFY11. However, the business is
going through restructuring and shifting mix from voice-based to platform-based
services, which explains the very high (voluntary as well as involuntary) attrition
levels. On an absolute basis, 6,381 employees left the firm (compared to 6,330 in
2QFY11), including 2,790 in IT Services and 3,591 in BPO business.
• By geography, ROW witnessed very strong revenue growth of 21.7% and
Europe grew 7.3% Q/Q. Noticeably, North America revenues grew only 0.7%,
which we believe is slightly concerning considering strong spending
environment.
• DSO decreased meaningfully to 55 days (on LTM basis) from 61 days last
quarter. Repeat business was almost flat at 94.5% compared to 94.3% in
Q3FY11.
Takeaways from Management Commentary
• Currently, vendor churn and increase in proportion of outsourcing is driving the
revenue growth rather than spending growth. Management suggested that clients
are cutting back on their legacy applications and investing in more
transformational projects (including cloud computing, mobility etc), providing
opportunity to the company to gain market share from existing vendors.
• Revenue growth in the US accrues largely from discretionary projects involving
services such as business intelligence, consulting, SOA implementation, ERP
implementation and integration, while legacy application growth is not
significant. However, in Continental Europe legacy applications are driving the
growth along with relatively newer service lines.
• Management pointed out 5 matters of concern for the Indian IT industry - (a)
Weak macro economic indicators, (b) forex movement, (c) tougher regulatory
conditions, (d) Middle East crisis and (e) supply side pressures. However, on the
positive side the penetration level of Indian IT industry in totals IT spending is
still in low-mid single digits providing a large market to explore.
• The company had hedges worth $265 mn at the end of the quarter, increasing
modestly from $256 in 2QFY11.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
HCL-Technologies Overweight
HCLT.BO, HCLT IN
Impressive revenue growth with good margin
expansion; reiterate OW though stock uptick overdone
• HCLT demonstrated a TCS-like performance in 3QFY11 (Mar-11 quarter)
for the first time in recent times. It tightened operations and impressively
improved margins while also growing revenues (+5.8% Q/Q to USD 915 mn).
Further, HCLT has also stated its confidence for further margin improvement in
the next quarter (4QFY11). However, this must be sustained for re-rating of the
stock. That said, the signs are encouraging and we reiterate OW.
• Stock price up-tick (up 10%) perhaps a bit overdone largely reflecting a
relief trade. The quarter (3QFY11) saw HCLT meet our expectations and those
of consensus, not materially beat them. The up-tick of the stock (up 10%
yesterday) seems overdone which we put down to a relief trade in view of the
prior anxiety among the buy-side created by the disappointing Infosys results.
• Highlights included improved margins and enhanced client mining metrics.
The count of USD 30 mn+ clients almost doubled on a LTM basis (from 10 in
3QFY10 to 19 in 3QFY11) suggesting that HCLT is improving and executing
on its multi-service positioning (apps + infra management). Also, we think
margin performance will alleviate the street’s primary concern with regard to
HCLT (EBIT margins up 130 bps Q/Q (pre ESOP costs)).
• Quarter specifics. Industry-wise, BFSI (top-line growth of 12.6% Q/Q) drove
revenue growth. Energy, Utilities and public sector (+7.1% Q/Q) and
Manufacturing (+6.3% Q/Q) also registered healthy revenue growth, while
other verticals witnessed modest growth. Telecom (+0.9%) is the only soft spot,
which we believe is indicative of spending pressures in the industry. Revenue
growth was driven by Infrastructure Services, Custom Application Services and
Enterprise Application Services, which grew 8.5%, 6.7% and 6.7% Q/Q. The
traction in HCLT’s enterprise application services is particularly pleasing as this
is the higher-value revenue stream that HCLT needs to ramp up following its
acquisition of AXON effective Dec 2008. BPO revenues were flat.
• Another positive coming out of the quarter was a decrease in HCLT’s attrition
(quarterly annualized attrition decreased to 17.7% for IT Services from 21.9% in
1QFY11). We believe the decline in attrition that we have observed in company
results so far (Infosys and Persistent also reported decline in attrition) should
reduce supply-side related pressures for the industry. Wage hikes are likely to be
more moderate in FY12 versus FY11 – a beneficial outcome for the industry.
• We reiterate our OW rating on the stock. We retain our Mar-12 price
target of Rs 560. Our estimates remain largely unchanged for FY12/13
Impressive margin expansion along with
strong revenue growth is commendable
HCLT reported EBIT margin (pre ESOP costs) expansion of 130 bps from 13.1% in
2QFY11 to 14.4%, and posted revenue growth of 5.8% in 3QFY11, which we
believe is impressive. Management had committed to focus on improving margins
and has delivered on this commitment. HCLT has exhibited revenue growth at a
CQGR of 7.3% over the last 4 quarters, which is commendable, but margin
deterioration in 1QFY11 was concerning and re-orientation towards margins should
alleviate some of these concerns. We believe the company is on track to achieve
its EBIT margin target of 15.3% (pre ESOP costs) in 4QFY11.
Tightening operations while still growing revenues is something which, except
TCS, no other company has been able to accomplish recently. It exhibits the
effectiveness of internal and external focus of the company. However, HCLT
needs to continue tightening its cost structure to improve margins for at least 2-
3 more quarters to build confidence in management's ability to control/manage
margins effectively.
Moreover, margin expansion was broad-based as Software and Infrastructure
Services, both registered margin expansion of 120 bps, while BPO EBIT loss has
also declined from 10.9% to 9.2%. Gross margin improvement and SG&A efficiency
drove the margin expansion. Gross margins improved 80 bps from 28.4% in 2QFY11
to 29.2% in 3QFY11, while SG&A as a % of sales declined from 15.2% to 14.7%.
Higher utilization and exchange rate benefits contributed to the gross margin
expansion. SG&A as a % of sales peaked at 15.4% in 1QFY11 and we expect this
ratio to continue declining in 4QFY11, before increasing in 1QFY12.
Revenue growth was broad-based and
convincing
HCLT reported strong and broad based revenue growth. All the verticals, service
lines and geographies reported positive revenue growth in 3QFY11. The company
has registered 7.3% CQGR over the last four quarters; hence fairly consistent
revenue growth performance. HCLT witnessed impressive Q/Q revenue growth in
BFSI (+12.6%), Energy, Utilities and Public sector (+7.1%) and Manufacturing
(+6.3%) verticals, while Healthcare, Retail, Telecom and other verticals’ growth was
soft but positive. Noticeably, CQGR in the last four quarters for Retail (+11.4%),
Healthcare (+9.5%) and Telecom (+4.4%) has been strong.
In terms of service lines, Infrastructure Services (+8.5%), Custom Applications
(+6.7%) and Enterprise Application Services (+6.7%) experienced mid to high single
digit growth rate. BPO growth was light but the business is going through
restructuring currently and the sale of certain accounts to Tangoe also impacted the
top-line by $3.6 mn. By geography, ROW drove the growth with 21.7% Q/Q
increase, while Europe revenues grew 7.3% as the company is experiencing revenue
traction in Continental Europe. Revenues from Americas grew only 0.7% during the
quarter, which we believe is the only concerning point of the quarter. However
Americas’ revenues have grown at a CQGR of 5.1% over the last four quarter, which
is healthy, if not strong in our view.
Improved client mining addresses some of the concerns we earlier identified in
our report “A progressive approach so far but work still lies ahead” (dated Dec.
10,2010). The multi-service positioning (apps + infra management) has started
to pay off and HCLT is seemingly able to cross-sell and up-sell its offerings. The
increase in $30 mn accounts from 10 in 3QFY10 to 19 in3QFY11 substantiates
HCLT’s ability to mine large clients effectively.
3QFY11 Highlights
• Revenues came in at $915 million, up 5.8% Q/Q and at Rs.41.4 billion in rupee
terms, up 5.6% from 2QFY11. Revenues grew 4.8% in constant currency terms,
primarily driven by volumes growth, while pricing was almost flat.
• Infrastructure Services (up 8.5% Q/Q in $ terms) and Software Services (+5.4%)
drove the revenue growth, while BPO continued to lag as top-line growth
moderated to 0.8% from 2.9% in 2QFY11 and 5.7% in 1QFY11. Notably, the
soft growth in BPO was because of the sale of certain Telecom Expense
Management accounts to Tangoe, a leading company in TEM space. These
accounts had quarterly run rate of $3.6 mn, including which BPO revenues
would have grown about 8%.
Table 2: Q3FY11 Quarterly Revenue growth drivers
Factor Impact
Volume 4.8%
Cross-currency tailwind 1.0%
US$ Revenue growth 5.8%
Source: Company reports and J.P. Morgan estimates.
• EBIT margins increased to 13.9% (post ESOP costs) in 3QFY11, an expansion
of 140 bps from 12.5% in 2QFY11. Improved gross margins (up 80 bps from
27.7% to 28.6%) and SG&A efficiency (50 bps impact) drove the margin
expansion. Notably, low margins are the primary concern about this
company and strong margin expansion this quarter suggests that
management is working towards alleviating these concerns.
• We estimate that Software services, which contributes more than 70% of the
total company revenues, witnessed pricing increase of 0.5% Q/Q as both onsite
(+1.1%) and offshore (+1.5%) pricing registered modest up-ticks. Volumes for
Software Services increased 4.9% Q/Q primarily driven by offshore volumes
(+5.6%), while onsite volumes were (+3.0%) up as well.
• Utilization (including trainees) for Software Services increased from 75.7% in
2QFY11 to 77.3%, as onsite utilization was up from 95.9% to 96.5% and
offshore utilization (including trainees) increased from 70.1% to 71.9%.
Utilization excluding trainees was up 120 bps from 79.8% to 80.9% in 2QFY11.
Offsite utilization ex trainees increased from 75.0% to 76.3%.
• HCLT’s new client additions continue to be robust as the company added
58 clients in the last four quarters. On LTM basis, net increase in million
dollar clients was 12, compared to 20 in 2QfY11 and 9 in 1QFY11.
• Financial services revenues grew double digit registering 12.6% Q/Q increase
(10.5% in constant currency (CC) terms). Energy, Utilities and Public Sector and
Manufacturing also witnessed healthy growth of 7.1% Q/Q and 6.3% Q/Q (6.3%
and 6.1% in CC terms), respectively. Media Publishing and Entertainment
(+2.3%) and Healthcare (+1.2%) grew modestly. Telecom and Retail verticals
were broadly flat with nominal increase on reported basis but slight decline on
constant currency basis. Weakness in Telecom points to continued spending
pressures in the industry.
• By business lines, Infrastructure Services registered strong growth of 8.5%.
Custom Application Services and Enterprise Application Services both grew
6.7% each. Engineering and R&D Services growth was light at 1.3%, while
BPO revenues were almost flat primarily because of sale of certain client
accounts to Tangoe.
• On LTM basis, revenues from the top 10 clients were up 4.2% Q/Q. Revenue
growth from top 20 clients was 4.7%. Non-top 20 clients grew at a higher rate
than top 20 clients.
• Proportion of fixed price contracts increased 50 bps from last quarter to 42.0%.
It has increased 150 bps y/y.
• HCLT reported net addition of 1,153 employees during the quarter, moderating
from 2,049 in 2QFY11 and 5,661 in 1QFY11. Software Services saw net
addition of 867 employees and gross addition of 2,939 people, while
Infrastructure Services’ net addition was 750 people and gross addition was
1,468 employees. BPO headcount continued to decrease (-464) despite hiring
3,127 employees as attrition continues to be very high. The gross hiring for the
quarter stood at 7,534.
• Quarterly annualized attrition for Software Services decreased modestly to
17.7% from 18.1% in 2QFY11. Infrastructure Services’ quarterly annualized
attrition was flat at 20.5%, hence consolidated IT Services’ attrition level
decreased from 18.6% to 18.3%. BPO continues to witness very high quarterly
attrition of 11.0%, slightly up from 10.8% in 2QFY11. However, the business is
going through restructuring and shifting mix from voice-based to platform-based
services, which explains the very high (voluntary as well as involuntary) attrition
levels. On an absolute basis, 6,381 employees left the firm (compared to 6,330 in
2QFY11), including 2,790 in IT Services and 3,591 in BPO business.
• By geography, ROW witnessed very strong revenue growth of 21.7% and
Europe grew 7.3% Q/Q. Noticeably, North America revenues grew only 0.7%,
which we believe is slightly concerning considering strong spending
environment.
• DSO decreased meaningfully to 55 days (on LTM basis) from 61 days last
quarter. Repeat business was almost flat at 94.5% compared to 94.3% in
Q3FY11.
Takeaways from Management Commentary
• Currently, vendor churn and increase in proportion of outsourcing is driving the
revenue growth rather than spending growth. Management suggested that clients
are cutting back on their legacy applications and investing in more
transformational projects (including cloud computing, mobility etc), providing
opportunity to the company to gain market share from existing vendors.
• Revenue growth in the US accrues largely from discretionary projects involving
services such as business intelligence, consulting, SOA implementation, ERP
implementation and integration, while legacy application growth is not
significant. However, in Continental Europe legacy applications are driving the
growth along with relatively newer service lines.
• Management pointed out 5 matters of concern for the Indian IT industry - (a)
Weak macro economic indicators, (b) forex movement, (c) tougher regulatory
conditions, (d) Middle East crisis and (e) supply side pressures. However, on the
positive side the penetration level of Indian IT industry in totals IT spending is
still in low-mid single digits providing a large market to explore.
• The company had hedges worth $265 mn at the end of the quarter, increasing
modestly from $256 in 2QFY11.
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