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Buy
HCL Technologies Ltd. (HCLT.BO)
Return Potential: 23% Equity Research
IMO: A sustainable advantage; incremental US$1bn by FY14; CL-Buy
Source of opportunity
We believe Infrastructure Management Outsourcing (IMO) will be the
fastest growth segment in global IT outsourcing over next few years. In
our view, HCL is one of the best positioned firms globally, with sustainable
competitive advantage in IMO. HCL posted 9.7% IMO revenue CQGR in
FY10/FY11 (vs. our 8.0% CQGR estimate made in Sep 2009). We revisit the
IMO opportunity now, and forecast 29% revenue CAGR in FY11-FY14E (an
extra US$1bn over US$830mn in FY11). We estimate IMO revenues to
reach 31% of HCL’s revenues by FY14E, driving 17%/21% sales /EPS CAGR
over FY11-14E. We add HCL to Conviction Buy List, with 28% pot. upside.
Catalyst
(1) Stable revenue growth, driven by resilient IMS business against the
backdrop of concerns over global IT spending. (2) News flows on new client
additions or deal wins could underscore its longer-term growth trajectory.
(3) Recovery in EBIT margin after 1QFY12, when wage hikes will compress it.
Valuation
Our 12-month Target Price of Rs501 (unchanged) is derived using Director’s
Cut methodology, using a val-ratio (EV/GCI to CROCI/WACC) of 1.3X (derived
from the average of HCL’s median and trough val-ratio). HCL is trading at
11.3X on FY13E EPS of Rs34.71, at a 25% discount to its 7-year historical
average of 15X. On concerns over global growth, HCL has fallen by 20% in
the past three months (vs. -15% for the sector). We view this as a good
buying opportunity, based on the greater resilience of HCL’s revenue
composition vs. its Indian peers and improving CROCI profile. Our bear case
of further weakness in the US/EU, suggests 13% downside vs. 28% upside to
our base case. We add HCL to our regional Conviction Buy List.
Key risks
Competitive threats to its IMO dominance with increased focus from peers,
significant slowdown in tech spending in 2012, Indian rupee appreciation.
INVESTMENT LIST MEMBERSHIP
Asia Pacific Buy List
Asia Pacific Conviction Buy List
Coverage View: Neutral
IMS Outsourcing expertise provides sustainable competitive edge
We believe Infrastructure Management Outsourcing (IMO) will be the fastest growth
segment in the global IT outsourcing industry; and in our view, HCL is one of the
best positioned firms globally, with a sustainable competitive advantage in IMO.
HCL posted 9.7% IMO revenue CQGR in FY10/FY11; higher than our 8.0% CQGR
estimate made in Sept. 2009 for the same period, (see our note of Sep 10, 2009 “RIM
services on strong trajectory in FY10, raise TP by 16% to Rs341”). We now revisit the
IMO opportunity, and forecast three-year revenue CAGR of 29% over FY11-FY14E.
This is an incremental US$1bn over the US$830mn in FY11). We forecast IMO
revenues to grow to 31% of the firm’s overall revenues by FY14E — driving
17%/21% revenue and EPS CAGR over FY11-14E.
We add HCL to the Conviction Buy List, with a potential upside of 28%.
IMO: a US$140bn addressable market with low Indian penetration
The global IMO market has been estimated by various research firms at US$120bn-
US$140bn (NASSCOM estimates around US$120bn). Of this, Indian IT firms derive
US$5.9bn as of 2010, implying a penetration of only 4%.
Key growth drivers for the industry are two-fold: (1) Favorable development for IMO
(development of Remote Management Tools, strong skill set in India, improving
Networks) and (2) Growing business need to offshore Infrastructure Management
(30% of cost savings estimated by McKinsey, desire to optimize resources)
In our view, IMO offers global CIOs the best lever to control costs and hence there
should be a sustained rise in offshoring. We forecast Indian IT revenues to grow to
US$10bn by 2013 at a 25% CAGR.
HCL has positioned itself as one of the top global IMO vendors
Among global vendors for IMO, HCL has moved up the value chain in the last five
years and is now rated highly vs. established vendors like IBM, Accenture, Wipro, and
CapGemini.
We believe this recognition and HCL’s expertise in the field will be a key sustainable
competitive advantage and expect this to translate to steady deal wins for HCL.
29% revenue CAGR from IMO to add $1bn incrementally by FY14
HCLT posted 9.7% IMO revenue CQGR in FY10/FY11; higher than our 8.0% CQGR
estimate made in Sept. 2009, (see our note of Sep 10, 2009 “RIM services on strong
trajectory in FY10, raise TP by 16% to Rs341”).
We revisit HCL’s IMO growth prospects against the backdrop of global concerns, and
believe HCL’s revenue outlook is highly resilient to economic cycles.
We recently lowered our forecasts for HCL (and the sector) to incorporate heightened
global macro risk concern. However, under our bear-case scenario of further
slowdown in the US/EU the impact on growth would be least for HCL, owing to its
significantly higher exposure to the IMO segment (23.3% vs. 10.6% for top-3 firms),
which we see as defensive in nature.
Therefore, we forecast a 29% revenue CAGR for its IMO business over the next 3
years and expect IMO to contribute to 31% of total revenues by FY14E (23% in FY11).
Overall, we forecast a 17% revenue and 21% EPS CAGR over FY2011-2014E, even
though we expect EBIT margins to remain flat in FY12E and FY14E at 14%, as the
company continues its investment into growth avenues.
Valuation at 25% discount to historical avg.; resilient growth
trajectory, add to Conviction List with potential upside of 28%
On concerns over global growth HCL’s stock price has fallen in line with the sector
(-20% vs.-15%) in the past three months. However, we see this fall as overdone in
light of the greater resilience of HCL’s revenue compositions vs. its Indian peers.
HCL is trading at 11.3X on FY13E EPS of Rs34.71, at a 25% discount to its 7-year
historical avg. P/E of 15X (24% discount to peers). On one-year forward EV/EBITDA,
the stock trades at a 28% discount to peers, which we believe is not warranted.
Our 12-month target price of Rs501 is derived using our returns based Director’s Cut
methodology, using a val-ratio (EV/GCI to CROCI/WACC) of 1.3X (derived from the
average of HCL’s median and trough val-ratios). Our target price implies a P/E of
14.4X on FY2013E EPS vs. a P/E of 17.3X for the large-caps, a discount of 16%.
We add HCL to our Conviction Buy List, and see it as offering the highest upside
potential of 28% among our coverage group.
Valuations: Improving CROCI trajectory, 25% disc. to historical avg.
We maintain our 12-month Director’s Cut-based target price of Rs501 which yields a
potential upside of 28%. HCL is trading at P/E of 11.3X on FY2013E EPS of Rs34.71, which
is a 25% discount to HCL’s 7-year historical average one-year forward P/E of 15X (avg.
trading range of 13X-17X) and at a 24% discount to the large-cap Indian IT companies.
Our target price implies FY2013E P/E of 14.4X, which is a 16% discount to our implied P/E
of 17.3X for the large-cap stocks in our coverage. We believe current valuations are
attractive considering the relative resilience of its revenue outlook and improving cash
returns for the company (see below).
Improving CROCI; Director’s Cut framework yields 28% upside
We forecast HCL’s CROCI to improve by 100 bps in FY12, as we maintain our revenue and
earnings forecast. However, our CROCI forecasts across the sector decline for FY13 as we
factor in US/EU slowdown (see, “Macro concerns may impact 2012 growth despite stable
NT outlook “, September 4, 2011) and expect HCL’s CROCI to be one of the least impacted
in the sector. On a 3-yr CROCI horizon, we forecast HCL to improve materially in its CROCI
trajectory, with 300bps improvement, which would place it in the 2nd quartile among our
coverage.
Risks
Key downside risks to our thesis include:
A significant slowdown in tech spending in FY2012 due to worsening macro
environment across the globe, especially in the US and EU. HCL has roughly 56% top
line exposure to the US and about 27% exposure to the EU.
Appreciation of the rupee against the dollar which could result in downside risk for
our estimates. Currently, our forecasts are based on an exchange rate of Rs45 per
US$.
Potential competitive dynamics in the IMO segment: especially as most of the larger
firms we met in our 2nd Annual Indian IT trip, highlighted IMO as a greater focus area
for growth.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Buy
HCL Technologies Ltd. (HCLT.BO)
Return Potential: 23% Equity Research
IMO: A sustainable advantage; incremental US$1bn by FY14; CL-Buy
Source of opportunity
We believe Infrastructure Management Outsourcing (IMO) will be the
fastest growth segment in global IT outsourcing over next few years. In
our view, HCL is one of the best positioned firms globally, with sustainable
competitive advantage in IMO. HCL posted 9.7% IMO revenue CQGR in
FY10/FY11 (vs. our 8.0% CQGR estimate made in Sep 2009). We revisit the
IMO opportunity now, and forecast 29% revenue CAGR in FY11-FY14E (an
extra US$1bn over US$830mn in FY11). We estimate IMO revenues to
reach 31% of HCL’s revenues by FY14E, driving 17%/21% sales /EPS CAGR
over FY11-14E. We add HCL to Conviction Buy List, with 28% pot. upside.
Catalyst
(1) Stable revenue growth, driven by resilient IMS business against the
backdrop of concerns over global IT spending. (2) News flows on new client
additions or deal wins could underscore its longer-term growth trajectory.
(3) Recovery in EBIT margin after 1QFY12, when wage hikes will compress it.
Valuation
Our 12-month Target Price of Rs501 (unchanged) is derived using Director’s
Cut methodology, using a val-ratio (EV/GCI to CROCI/WACC) of 1.3X (derived
from the average of HCL’s median and trough val-ratio). HCL is trading at
11.3X on FY13E EPS of Rs34.71, at a 25% discount to its 7-year historical
average of 15X. On concerns over global growth, HCL has fallen by 20% in
the past three months (vs. -15% for the sector). We view this as a good
buying opportunity, based on the greater resilience of HCL’s revenue
composition vs. its Indian peers and improving CROCI profile. Our bear case
of further weakness in the US/EU, suggests 13% downside vs. 28% upside to
our base case. We add HCL to our regional Conviction Buy List.
Key risks
Competitive threats to its IMO dominance with increased focus from peers,
significant slowdown in tech spending in 2012, Indian rupee appreciation.
INVESTMENT LIST MEMBERSHIP
Asia Pacific Buy List
Asia Pacific Conviction Buy List
Coverage View: Neutral
IMS Outsourcing expertise provides sustainable competitive edge
We believe Infrastructure Management Outsourcing (IMO) will be the fastest growth
segment in the global IT outsourcing industry; and in our view, HCL is one of the
best positioned firms globally, with a sustainable competitive advantage in IMO.
HCL posted 9.7% IMO revenue CQGR in FY10/FY11; higher than our 8.0% CQGR
estimate made in Sept. 2009 for the same period, (see our note of Sep 10, 2009 “RIM
services on strong trajectory in FY10, raise TP by 16% to Rs341”). We now revisit the
IMO opportunity, and forecast three-year revenue CAGR of 29% over FY11-FY14E.
This is an incremental US$1bn over the US$830mn in FY11). We forecast IMO
revenues to grow to 31% of the firm’s overall revenues by FY14E — driving
17%/21% revenue and EPS CAGR over FY11-14E.
We add HCL to the Conviction Buy List, with a potential upside of 28%.
IMO: a US$140bn addressable market with low Indian penetration
The global IMO market has been estimated by various research firms at US$120bn-
US$140bn (NASSCOM estimates around US$120bn). Of this, Indian IT firms derive
US$5.9bn as of 2010, implying a penetration of only 4%.
Key growth drivers for the industry are two-fold: (1) Favorable development for IMO
(development of Remote Management Tools, strong skill set in India, improving
Networks) and (2) Growing business need to offshore Infrastructure Management
(30% of cost savings estimated by McKinsey, desire to optimize resources)
In our view, IMO offers global CIOs the best lever to control costs and hence there
should be a sustained rise in offshoring. We forecast Indian IT revenues to grow to
US$10bn by 2013 at a 25% CAGR.
HCL has positioned itself as one of the top global IMO vendors
Among global vendors for IMO, HCL has moved up the value chain in the last five
years and is now rated highly vs. established vendors like IBM, Accenture, Wipro, and
CapGemini.
We believe this recognition and HCL’s expertise in the field will be a key sustainable
competitive advantage and expect this to translate to steady deal wins for HCL.
29% revenue CAGR from IMO to add $1bn incrementally by FY14
HCLT posted 9.7% IMO revenue CQGR in FY10/FY11; higher than our 8.0% CQGR
estimate made in Sept. 2009, (see our note of Sep 10, 2009 “RIM services on strong
trajectory in FY10, raise TP by 16% to Rs341”).
We revisit HCL’s IMO growth prospects against the backdrop of global concerns, and
believe HCL’s revenue outlook is highly resilient to economic cycles.
We recently lowered our forecasts for HCL (and the sector) to incorporate heightened
global macro risk concern. However, under our bear-case scenario of further
slowdown in the US/EU the impact on growth would be least for HCL, owing to its
significantly higher exposure to the IMO segment (23.3% vs. 10.6% for top-3 firms),
which we see as defensive in nature.
Therefore, we forecast a 29% revenue CAGR for its IMO business over the next 3
years and expect IMO to contribute to 31% of total revenues by FY14E (23% in FY11).
Overall, we forecast a 17% revenue and 21% EPS CAGR over FY2011-2014E, even
though we expect EBIT margins to remain flat in FY12E and FY14E at 14%, as the
company continues its investment into growth avenues.
Valuation at 25% discount to historical avg.; resilient growth
trajectory, add to Conviction List with potential upside of 28%
On concerns over global growth HCL’s stock price has fallen in line with the sector
(-20% vs.-15%) in the past three months. However, we see this fall as overdone in
light of the greater resilience of HCL’s revenue compositions vs. its Indian peers.
HCL is trading at 11.3X on FY13E EPS of Rs34.71, at a 25% discount to its 7-year
historical avg. P/E of 15X (24% discount to peers). On one-year forward EV/EBITDA,
the stock trades at a 28% discount to peers, which we believe is not warranted.
Our 12-month target price of Rs501 is derived using our returns based Director’s Cut
methodology, using a val-ratio (EV/GCI to CROCI/WACC) of 1.3X (derived from the
average of HCL’s median and trough val-ratios). Our target price implies a P/E of
14.4X on FY2013E EPS vs. a P/E of 17.3X for the large-caps, a discount of 16%.
We add HCL to our Conviction Buy List, and see it as offering the highest upside
potential of 28% among our coverage group.
Valuations: Improving CROCI trajectory, 25% disc. to historical avg.
We maintain our 12-month Director’s Cut-based target price of Rs501 which yields a
potential upside of 28%. HCL is trading at P/E of 11.3X on FY2013E EPS of Rs34.71, which
is a 25% discount to HCL’s 7-year historical average one-year forward P/E of 15X (avg.
trading range of 13X-17X) and at a 24% discount to the large-cap Indian IT companies.
Our target price implies FY2013E P/E of 14.4X, which is a 16% discount to our implied P/E
of 17.3X for the large-cap stocks in our coverage. We believe current valuations are
attractive considering the relative resilience of its revenue outlook and improving cash
returns for the company (see below).
Improving CROCI; Director’s Cut framework yields 28% upside
We forecast HCL’s CROCI to improve by 100 bps in FY12, as we maintain our revenue and
earnings forecast. However, our CROCI forecasts across the sector decline for FY13 as we
factor in US/EU slowdown (see, “Macro concerns may impact 2012 growth despite stable
NT outlook “, September 4, 2011) and expect HCL’s CROCI to be one of the least impacted
in the sector. On a 3-yr CROCI horizon, we forecast HCL to improve materially in its CROCI
trajectory, with 300bps improvement, which would place it in the 2nd quartile among our
coverage.
Risks
Key downside risks to our thesis include:
A significant slowdown in tech spending in FY2012 due to worsening macro
environment across the globe, especially in the US and EU. HCL has roughly 56% top
line exposure to the US and about 27% exposure to the EU.
Appreciation of the rupee against the dollar which could result in downside risk for
our estimates. Currently, our forecasts are based on an exchange rate of Rs45 per
US$.
Potential competitive dynamics in the IMO segment: especially as most of the larger
firms we met in our 2nd Annual Indian IT trip, highlighted IMO as a greater focus area
for growth.
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