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We summarize below key highlights of HCL Tech management views on
demand and margins:
Looking to reinvest excess of stated 14% margin to drive higher
growth
Margins made above its guided levels of 14% will be redeployed in the
business to drive higher growth. The investments would be made in 1)
sales 2) solutions/platforms and 3) Passing on benefits of rupee
depreciation to customers for large long term assured business on select
deals.
Rupee depreciation benefit to be passed to customers on select
deals: HCL Tech is looking to price new deals at USD-INR rates of 48-
49 (vs 45-46 earlier), whereby the company makes 14% margin and
gives the benefit of rupee depreciation to the client. HCL Tech would
protect itself against future rupee appreciation by taking long term
hedges over the deal duration, as getting longer terms hedges is not an
issue according to the management (current USD/INR forward premium
is at ~3-3.5%, which leaves some rupee depreciation benefit to HCL
Tech). The company indicates this would not be a blanket policy, but
could apply to larger transactions which provide 3-5 years of significant
visibility or situations where HCL Tech needs to pay entry ticket premium
to get a look in. The company is confident that at renewal of these deals,
the contract structuring would ensure that they make similar margins
even in a rupee appreciation scenario. HCL says it is taking advantage
of the rupee volatility by giving customers the benefit.
Employee pyramid more a long term lever: Increasing fresher
proportions is a long term margin lever according to the company. (HCL
Tech has been hiring ~80% laterals in the past, which have over the last
two quarters come down to 55-60% levels). HCLT currently has training
centre at Manesar and is building one at Nagpur, which will have
capacity of 5000-6000 people to be trained at one go (completion over
the next 3 years). Utilisation including trainees is a marginal lever
according to the company and can move up by 100-200bps.
Demand outlook continues to be strong, deal signings on track
Increased offshoring due to crisis: Euro crisis and weak global macro
is leading to 1) increased outsourcing and 2) higher vendor churn as
customers look to cut costs more and fund change-the-business projects
(CTB) from savings from run-the-business (RTB) projects. Most of the
vendor churn is happening on the Application management outsourcing
side. In BPO/SAP projects no major vendor change is happening.
Vendor management functions are ill developed in large organisations as
they have too many vendors and this is being re-assessed.
Indian offshore vendors gaining market share: Indian vendors are
gaining market share as a result of consolidation and vendor churn.
Indian offshore providers (IOP) have increased market share from 12%
to 17% over the last 2-3 years. Vendor change is happening on 1) better
pricing 2) better flexibility. Global vendors are less flexible than Indian
vendors as the cost of redeployment of resources is high. In contrast,
IOP’s can be flexible as the growth rate is high and resources can easily
be redeployed.
Deal activity robust but vendors cautious on announcements:
OND’11 will be biggest quarter in terms of deal decision making. TPI
indicates that HCL is among the top 6 vendors across all regions.
Despite robust deal activity, deal win announcements might be limited as
it remains a sensitive subject for vendors/clients in the current high
unemployment scenario in developed markets. HCLT says its deal-win
ratio is better than that during 2008. According to the company, the
revenue impact of the deal pipeline will be seen in the AMJ quarter
(4QFY12); OND quarter will see normal seasonality; BFS and
Manufacturing continue to see a good pipeline; while stress in the
Telecom vertical continues.
CTB activity has dried out: 50% of HCL Tech business comes from
CTB work. Cost cutting is not a trigger in CTB as work can’t be moved
offshore because it is higher up the value chain.
SAP license growth mostly in analytics and not ERP: According to
the management, most of the SAP new license growth is being driven by
analytics – which are short term spends. The implementation work on
analytics licenses is only 0.7x of the license fee, unlike ~3x in ERP
rollouts. This trend does not benefit HCL Tech’s Axon piece, which is
purely core ERP work. Analytics and middleware is reported under
Custom applications for HCL Tech.
Nomura view:
We remain convinced about HCL Tech’s large deal winning prowess
and revenue surety stemming from the 1) biggest deal pipeline and
better deal win rates than the company is guiding for and 2) the rampup
in 32 transformational deals signed over the past 2 quarters.
Management commentary on deal signings and pipeline was
reassuring.
Management intention of reinvesting excess margins into sales
investments to drive higher growth is acceptable, if it generates
desired results the stock can re-rate, in our view.
However, we view HCL Tech’s intention of passing the benefits of
rupee depreciation to clients to gain market share on select deals as a
negative. This practise comes with an additional risk of lower reported
EBIT margins, if discounting becomes widespread. This is because
the company is expected to price deals at ~49 USD/INR and then
hedge it; if the rupee were to appreciate, gross margins would be
lower, while gains on the hedges would be reported at the forex line
(below EBIT). We will be watching gross margin movements at HCL
Tech to ascertain if this practice is becoming widespread and going
against management statements. Our current assumptions build in
flattish margin expectations at ~14% over FY12-13F.
We expect US$ revenue CAGR of 18% and EPS of CAGR of 24% over
FY11-13F and find the stock attractively valued at ~11x FY13F earnings.
Maintain Buy.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
We summarize below key highlights of HCL Tech management views on
demand and margins:
Looking to reinvest excess of stated 14% margin to drive higher
growth
Margins made above its guided levels of 14% will be redeployed in the
business to drive higher growth. The investments would be made in 1)
sales 2) solutions/platforms and 3) Passing on benefits of rupee
depreciation to customers for large long term assured business on select
deals.
Rupee depreciation benefit to be passed to customers on select
deals: HCL Tech is looking to price new deals at USD-INR rates of 48-
49 (vs 45-46 earlier), whereby the company makes 14% margin and
gives the benefit of rupee depreciation to the client. HCL Tech would
protect itself against future rupee appreciation by taking long term
hedges over the deal duration, as getting longer terms hedges is not an
issue according to the management (current USD/INR forward premium
is at ~3-3.5%, which leaves some rupee depreciation benefit to HCL
Tech). The company indicates this would not be a blanket policy, but
could apply to larger transactions which provide 3-5 years of significant
visibility or situations where HCL Tech needs to pay entry ticket premium
to get a look in. The company is confident that at renewal of these deals,
the contract structuring would ensure that they make similar margins
even in a rupee appreciation scenario. HCL says it is taking advantage
of the rupee volatility by giving customers the benefit.
Employee pyramid more a long term lever: Increasing fresher
proportions is a long term margin lever according to the company. (HCL
Tech has been hiring ~80% laterals in the past, which have over the last
two quarters come down to 55-60% levels). HCLT currently has training
centre at Manesar and is building one at Nagpur, which will have
capacity of 5000-6000 people to be trained at one go (completion over
the next 3 years). Utilisation including trainees is a marginal lever
according to the company and can move up by 100-200bps.
Demand outlook continues to be strong, deal signings on track
Increased offshoring due to crisis: Euro crisis and weak global macro
is leading to 1) increased outsourcing and 2) higher vendor churn as
customers look to cut costs more and fund change-the-business projects
(CTB) from savings from run-the-business (RTB) projects. Most of the
vendor churn is happening on the Application management outsourcing
side. In BPO/SAP projects no major vendor change is happening.
Vendor management functions are ill developed in large organisations as
they have too many vendors and this is being re-assessed.
Indian offshore vendors gaining market share: Indian vendors are
gaining market share as a result of consolidation and vendor churn.
Indian offshore providers (IOP) have increased market share from 12%
to 17% over the last 2-3 years. Vendor change is happening on 1) better
pricing 2) better flexibility. Global vendors are less flexible than Indian
vendors as the cost of redeployment of resources is high. In contrast,
IOP’s can be flexible as the growth rate is high and resources can easily
be redeployed.
Deal activity robust but vendors cautious on announcements:
OND’11 will be biggest quarter in terms of deal decision making. TPI
indicates that HCL is among the top 6 vendors across all regions.
Despite robust deal activity, deal win announcements might be limited as
it remains a sensitive subject for vendors/clients in the current high
unemployment scenario in developed markets. HCLT says its deal-win
ratio is better than that during 2008. According to the company, the
revenue impact of the deal pipeline will be seen in the AMJ quarter
(4QFY12); OND quarter will see normal seasonality; BFS and
Manufacturing continue to see a good pipeline; while stress in the
Telecom vertical continues.
CTB activity has dried out: 50% of HCL Tech business comes from
CTB work. Cost cutting is not a trigger in CTB as work can’t be moved
offshore because it is higher up the value chain.
SAP license growth mostly in analytics and not ERP: According to
the management, most of the SAP new license growth is being driven by
analytics – which are short term spends. The implementation work on
analytics licenses is only 0.7x of the license fee, unlike ~3x in ERP
rollouts. This trend does not benefit HCL Tech’s Axon piece, which is
purely core ERP work. Analytics and middleware is reported under
Custom applications for HCL Tech.
Nomura view:
We remain convinced about HCL Tech’s large deal winning prowess
and revenue surety stemming from the 1) biggest deal pipeline and
better deal win rates than the company is guiding for and 2) the rampup
in 32 transformational deals signed over the past 2 quarters.
Management commentary on deal signings and pipeline was
reassuring.
Management intention of reinvesting excess margins into sales
investments to drive higher growth is acceptable, if it generates
desired results the stock can re-rate, in our view.
However, we view HCL Tech’s intention of passing the benefits of
rupee depreciation to clients to gain market share on select deals as a
negative. This practise comes with an additional risk of lower reported
EBIT margins, if discounting becomes widespread. This is because
the company is expected to price deals at ~49 USD/INR and then
hedge it; if the rupee were to appreciate, gross margins would be
lower, while gains on the hedges would be reported at the forex line
(below EBIT). We will be watching gross margin movements at HCL
Tech to ascertain if this practice is becoming widespread and going
against management statements. Our current assumptions build in
flattish margin expectations at ~14% over FY12-13F.
We expect US$ revenue CAGR of 18% and EPS of CAGR of 24% over
FY11-13F and find the stock attractively valued at ~11x FY13F earnings.
Maintain Buy.
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