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HCL Technologies (HCLT)
Technology
Rupee to the rescue. HCLT exceeded our net income estimate on 2.5% EBITDA beat
and lower-than-expected tax rate. Revenues grew in line with our estimate though
lower than peers for the second consecutive quarter. This performance is consistent
with our view that the HCLT story is either revenue growth or margin but not both.
We cut our US$ revenue growth estimate for FY2012-14E by 2.5-3.5% though our EPS
estimates increase by 2.6-4.7% due to change in Re/US$ assumptions. Maintain
REDUCE rating with target price of Rs460/share (Rs450 earlier).
2QFY12 results beat lowered expectations
HCLT reported in-line revenue growth but better-than-expected earnings. The company reported
revenues of US$1,022 mn, a qoq growth of 2%. EBITDA margin (after stock compensation charge)
increased 140 bps qoq to 18.1%; our expectation was 17.8%. Net income of Rs5.53 bn was 7%
ahead of our estimate led by (1) modest beat at the EBITDA level and (2) lower-than-expected tax
rate at 25.8% versus our estimate and company guidance of 28%.
Revenue growth led by software services; infra segment revenue declines
Revenue growth was led by IT services business (+3.8% qoq) even as infra revenues declined 3%
sequentially. BPO revenues were flat qoq. Growth in IT services was led by a volume growth of
4.9%. HCLT attributed revenue weakness in infra segment to a steep decline in India SI revenues
on account of the company renegotiating certain contracts rendered unviable by FX movements.
Further disclosures would help in appreciating the impact of new deal wins
HCLT reported 18 deal wins with TCV of US$1 bn+ in 2QFY12. We are enthused with the
management’s optimism and company’s disclosure on achieving this milestone. However, more
disclosures on execution timeframe of the signed TCVs, order backlog, and TCV signed in previous
quarters are required to put a context to this number and appreciate its significance. This would
go a long way in the Street (or at least us) sharing management’s enthusiasm on record TCVs of
deals signed. Limited and infrequent disclosure on deal TCVs renders this just a ‘good to
know’ number, in our view.
Difficult to argue for downside though not attractive enough to deserve rating upgrade
We cut revenue growth estimate by 2.5-3.5% for FY2012-14E on the back of changes to crosscurrency
assumptions and marginal cut in volume estimates. Revision in our economist’s Re/US$
rate drives 2.6-4.7% earnings upgrade. We maintain REDUCE rating with end-FY2013E target of
Rs460/share (Rs450 earlier), valuing the company at 11.5X FY2013E earnings; multiple assigned
captures inferior normalized FCF generation potential and difference in accounting year-end.
Revenue growth or profitability
The HCLT story revolves around better-than-peers revenue growth driven by margin sacrifice.
However, it was the surprise at the margin level which triggered positive reaction for the
stock price post results even as the company underperformed peers on revenue growth for
the second consecutive quarter. Even over a longer period of six quarters, HCLT has
underperformed TCS and CTSH on revenue growth and TCS, CTSH and Infosys on EBITDA
growth.
Reasonable free cash generation; FCF/ EBITDA ratio at 50% for the quarter
HCLT reported free cash generation of US$95.2 mn in 2QFY12 and US$76.5 mn in 1HFY12
(the company had a negative FCF of US$18.7 mn in 1QFY12). 2QFY12 FCF generation may
have been aided by forex liabilities on loss-making forward contracts which are shown in
current liabilities (current liabilities increased US$21.6 mn qoq). Operating cash generated
was US$132 mn for the quarter, 71% of EBITDA (post option expenses). Receivables days
including unbilled increased by 2 days qoq to 76.
Other results and earnings call highlights
HCLT attributed the steep decline in India SI revenues (which drove the 3% qoq dip in
Infra revenues) to the company deciding to pause execution of certain public sector
projects that have been rendered unviable on profitability on account of adverse currency
movements. Essentially, the cost of imported software and hardware bundled into such
deals has gone up on account of sharp Rupee depreciation. This has made what we
presume are fixed-price Rupee contracts unviable on profitability and forced HCLT to take
a relook at some of these contracts. We are surprised though that HCLT chose not to
hedge the cost of software and hardware purchase embedded in these contracts.
From a vertical standpoint, growth was led by life sciences (+17% qoq on CC) and retail
and CPG (+8% qoq). Telecom vertical revenues declined 3% qoq, while BFSI was up a
robust 6%.
Among service lines, Enterprise Applications Services had a strong quarter growing 6.5%
qoq in constant currency terms. BPO revenues were flat in US$ terms and up a modest
1.6% qoq in CC terms.
HCLT added net 2,556 employees to take end-Dec 2011 headcount to a little over 83,000.
Voluntary attrition was down marginally qoq at 15.7%.
Marked improvement in the quality of top-10 accounts. From four of the top-10 clients in
G-500 three years back, all 10 are now from G-500. The company has also increased its
US$100 mn+ relationships (TTM basis) to three now, from one in the Sep-2011 quarter.
Hedges outstanding at end-Dec 2011 stood at US$1.15 bn, an increase from US$713 mn
at end-Sep 2011. US$171 mn of these are balance sheet hedges.
The company indicated that it may decide to re-invest some of the currency benefits back
into the business depending on new deal opportunities in the market.
In line with commentary from larger peers Infosys and TCS, HCLT also expects
discretionary spends to be slow in the near term on account of delays in decision-making.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
HCL Technologies (HCLT)
Technology
Rupee to the rescue. HCLT exceeded our net income estimate on 2.5% EBITDA beat
and lower-than-expected tax rate. Revenues grew in line with our estimate though
lower than peers for the second consecutive quarter. This performance is consistent
with our view that the HCLT story is either revenue growth or margin but not both.
We cut our US$ revenue growth estimate for FY2012-14E by 2.5-3.5% though our EPS
estimates increase by 2.6-4.7% due to change in Re/US$ assumptions. Maintain
REDUCE rating with target price of Rs460/share (Rs450 earlier).
2QFY12 results beat lowered expectations
HCLT reported in-line revenue growth but better-than-expected earnings. The company reported
revenues of US$1,022 mn, a qoq growth of 2%. EBITDA margin (after stock compensation charge)
increased 140 bps qoq to 18.1%; our expectation was 17.8%. Net income of Rs5.53 bn was 7%
ahead of our estimate led by (1) modest beat at the EBITDA level and (2) lower-than-expected tax
rate at 25.8% versus our estimate and company guidance of 28%.
Revenue growth led by software services; infra segment revenue declines
Revenue growth was led by IT services business (+3.8% qoq) even as infra revenues declined 3%
sequentially. BPO revenues were flat qoq. Growth in IT services was led by a volume growth of
4.9%. HCLT attributed revenue weakness in infra segment to a steep decline in India SI revenues
on account of the company renegotiating certain contracts rendered unviable by FX movements.
Further disclosures would help in appreciating the impact of new deal wins
HCLT reported 18 deal wins with TCV of US$1 bn+ in 2QFY12. We are enthused with the
management’s optimism and company’s disclosure on achieving this milestone. However, more
disclosures on execution timeframe of the signed TCVs, order backlog, and TCV signed in previous
quarters are required to put a context to this number and appreciate its significance. This would
go a long way in the Street (or at least us) sharing management’s enthusiasm on record TCVs of
deals signed. Limited and infrequent disclosure on deal TCVs renders this just a ‘good to
know’ number, in our view.
Difficult to argue for downside though not attractive enough to deserve rating upgrade
We cut revenue growth estimate by 2.5-3.5% for FY2012-14E on the back of changes to crosscurrency
assumptions and marginal cut in volume estimates. Revision in our economist’s Re/US$
rate drives 2.6-4.7% earnings upgrade. We maintain REDUCE rating with end-FY2013E target of
Rs460/share (Rs450 earlier), valuing the company at 11.5X FY2013E earnings; multiple assigned
captures inferior normalized FCF generation potential and difference in accounting year-end.
Revenue growth or profitability
The HCLT story revolves around better-than-peers revenue growth driven by margin sacrifice.
However, it was the surprise at the margin level which triggered positive reaction for the
stock price post results even as the company underperformed peers on revenue growth for
the second consecutive quarter. Even over a longer period of six quarters, HCLT has
underperformed TCS and CTSH on revenue growth and TCS, CTSH and Infosys on EBITDA
growth.
Reasonable free cash generation; FCF/ EBITDA ratio at 50% for the quarter
HCLT reported free cash generation of US$95.2 mn in 2QFY12 and US$76.5 mn in 1HFY12
(the company had a negative FCF of US$18.7 mn in 1QFY12). 2QFY12 FCF generation may
have been aided by forex liabilities on loss-making forward contracts which are shown in
current liabilities (current liabilities increased US$21.6 mn qoq). Operating cash generated
was US$132 mn for the quarter, 71% of EBITDA (post option expenses). Receivables days
including unbilled increased by 2 days qoq to 76.
Other results and earnings call highlights
HCLT attributed the steep decline in India SI revenues (which drove the 3% qoq dip in
Infra revenues) to the company deciding to pause execution of certain public sector
projects that have been rendered unviable on profitability on account of adverse currency
movements. Essentially, the cost of imported software and hardware bundled into such
deals has gone up on account of sharp Rupee depreciation. This has made what we
presume are fixed-price Rupee contracts unviable on profitability and forced HCLT to take
a relook at some of these contracts. We are surprised though that HCLT chose not to
hedge the cost of software and hardware purchase embedded in these contracts.
From a vertical standpoint, growth was led by life sciences (+17% qoq on CC) and retail
and CPG (+8% qoq). Telecom vertical revenues declined 3% qoq, while BFSI was up a
robust 6%.
Among service lines, Enterprise Applications Services had a strong quarter growing 6.5%
qoq in constant currency terms. BPO revenues were flat in US$ terms and up a modest
1.6% qoq in CC terms.
HCLT added net 2,556 employees to take end-Dec 2011 headcount to a little over 83,000.
Voluntary attrition was down marginally qoq at 15.7%.
Marked improvement in the quality of top-10 accounts. From four of the top-10 clients in
G-500 three years back, all 10 are now from G-500. The company has also increased its
US$100 mn+ relationships (TTM basis) to three now, from one in the Sep-2011 quarter.
Hedges outstanding at end-Dec 2011 stood at US$1.15 bn, an increase from US$713 mn
at end-Sep 2011. US$171 mn of these are balance sheet hedges.
The company indicated that it may decide to re-invest some of the currency benefits back
into the business depending on new deal opportunities in the market.
In line with commentary from larger peers Infosys and TCS, HCLT also expects
discretionary spends to be slow in the near term on account of delays in decision-making.
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