HCL Tech: Good quarter; maintain Accumulate: Alchemy

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Good quarter; maintain Accumulate
HCL Technologies (HCLT) 1QFY11 revenues though marginally ahead of our
estimates, net profit came in below expectations on higher than expected margin
decline. Despite strong and broad-based revenue outlook we are keeping our
estimates unchanged on margin concerns. We maintain Accumulate rating with a
increased target price of `480.
Strong revenue momentum continues
Revenues grew 9%QoQ to US$804mn, 2.3% higher than our estimates. In constant currency terms
revenues grew 7.4%QoQ to US$792mn. Volumes growth of 7.9%QoQ and increase in blended
realisation by 1.3%QoQ led to revenue growth of 9.3% in software services segment. Excluding
cross-currency benefits price realisations remained stable QoQ. Momentum in infrastructure services
continued as revenues increased 8.9%QoQ. BPO services, after declining in last four quarters, saw
stability with revenue growth of 5.7%QoQ. Revenues in rupee terms at Rs36.1bn grew 5.4%QoQ
due to convenience translation at Rs44.9/US$ as compared to Rs46.4/US$ in 4QFY10.
Margins decline further on wage hikes and SG&A investments
EBITDA margin declined for the fourth consecutive quarter by 240bps QoQ to 16.3%. Though the
decline is lower than the management’s guidance of 300bps, it is higher than our estimate of -
141bps. Margins were impacted by salary hikes (229bps), higher SG&A expenses (98bps) and lower
utilisation (20bps). The impact was offset partially by currency benefits (52bps) and efficiency gains
(53bps). IT services EBTIDA margin was most impacted with a 330bps QoQ decline to 17.9%; this is
the lowest ever for the segment. EBITDA margin for infrastructure services declined by 100bps QoQ
to 17.8% whereas BPO saw an improvement of 250bps QoQ to -8.7%. Net profit for 1QFY11 was
Rs3,225mn, 7% below our estimate because of lower-than-expected margins and other income.
Growth across the board
Revenues from Europe and Asia-Pacific grew strong at 18.3% and 20% QoQ respectively. Growth
in US was moderate at 2.8% QoQ. In IT services, custom application development grew strongest
at 15.2% QoQ; enterprise application services grew 6.5% QoQ after increasing 11.7% in 4QFY10.
All verticals grew on QoQ basis. BFSI /telecom/manufacturing grew 10%/10%/9% whereas retail
and healthcare grew 13% and 12% respectively. Employee recruitment remained strong with gross
and net additions of 11,785 and 5,661. Offshore utilisation, including trainees, in software services
has reduced by 520bps to 70.1% in 1QFY11.
Estimates remain unchanged
The trend of profitless revenue growth for HCLT continued in 1QFY11. In last four quarters, the
company has added incremental revenues of US$570mn, however incremental EBITDA has been
just US$32mn. Though we believe the margin trend to improve in coming quarters as benefits of
investments in employee bench and SG&A to yield results, we expect FY11 EBITDA margin to be at
18.5% in FY11 as compared to 21.9% and 20.5% in FY09 and FY10 respectively.
Valuations
We are raising our target P/E multiple for HCLT from 14.5x to 16x FY12 earnings. This is at 30%
discount to our target P/E of 23x for Infosys. We raise our target price to `480, an upside of 10%
from CMP. We maintain Accumulate rating on the stock.