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HCL Technologies - Accumulate -1QFY2011 Result Update
Broad-based growth momentum continues: For 1QFY2011,
HCL Technologies (HCL Tech) reported higher-than-expected
revenue at US $803.8mn (v/s our estimate of US$ 792.5mn),
up 9% qoq. Growth was backed by volume growth of 7.4% in
IT services and cross-currency benefit of 1.6%. Growth again
proved to be broad-based, spanning across verticals,
geographies and service lines with the BPO segment growing
5.7% qoq after posting de-growth since 4QFY2009.
EBIT margins slip: During the quarter, EBIT margins slipped by
242bp qoq on the back of a) annual wage inflation in July
2010, b) weak utilisations with increased hiring of freshers as
well as laterals to create capacity for foreseen demand and c)
higher SG&A to encash on the strong deal flow.
Outlook and valuation
HCL Tech is witnessing a strong deal pipeline for
October-December 2010, which is almost 25% higher than
that witnessed in October-December 2008, which witnessed
total contract value (TCV) of almost US $1bn. The company
has been witnessing an 8.5% volume CQGR over 2QFY2010-
1QFY2011 in its core software business on the back of the
return of discretionary type of spending i.e., more
transformational engagements with increasing components of
enterprise application services. Also, clients are increasingly
looking at outsourcing engineering and R&D services to encash
the surge in consumer spending. Infrastructure management,
which proved to be the growth driver even in the downturn, has
also witnessed double-digit revenue growth at a 10% CQGR
over 1QFY2010-1QFY2011. Further, management is witnessing
a rise in outsourcing infrastructure and applications by clients
to derive cost efficiencies.
We expect HCL Tech to be the outperformer at the volume front
amongst Tier-I companies on the back of higher value services
portfolio, which is gaining momentum with clients' businesses
getting to normalcy. We expect revenue in dollar terms to grow
at a 27% CAGR over FY2010-12, with a 24% CAGR in rupee
terms over the same period. At the operating front, the company
has many levers such as 1) normalising employee pyramid (i.e.
hiring more low-cost freshers), 2) reaping the benefits of high
investments in SG&A planned in 1HFY2011, 3) increasing
utilisation and 4) turning around the BPO business by returning
it to profitability by 2HFY2012. Going forward, we expect
EBITDA to grow at a 17% CAGR over FY2010-12, but PAT
growth will be much higher at a 34% CAGR over the same
period on the back of nil forex losses, improved profitability in
FY2012 and better other income to be accrued from higher
liquid investments.
At `423, the stock is trading at 13.4x FY2012 EPS of `31.9 at
a 37% discount to Infosys (as compared to its
one-year historical discount of 35%). We value the stock at 14.5x
FY2012 EPS. We revise our rating on the stock to Accumulate
(earlier Neutral) with a Target Price of `462.
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