HCL TECHNOLOGIES Delivering revenue growth (Sept qtr):: Edelweiss

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􀂃 Impressive scale up in business
HCL Technologies (HCLT) reported yet another quarter of strong performance
with revenue growth of 7.4% Q-o-Q in constant currency terms. It reported
consolidated revenues of USD 804 mn, a growth of 9% Q-o-Q and 28% Y-o-Y,
higher than our forecast of USD 772 mn. This was driven by 9% Q-o-Q growth in
IT services and infrastructure management services (IMS). BPO business grew
2.9% Q-o-Q in constant currency terms, after seven consecutive quarters of
decline. It won 14 major deals during the quarter. HCLT is focused on cross
selling other services to its existing clients, who are sourcing only IMS currently.
It reported 25% Q-o-Q growth in revenues from its top 10-20 clients.
􀂃 Margins crash by over 600bps Y-o-Y; seem to have bottomed out
HCLT’s EBITDA margins have declined by 640bps, to 16.3% in the past four
quarters, mainly due to massive hiring leading to lower utilisation and higher SG&A
investments. While the margin decline of 270 bps Q-o-Q in the September 2010
quarter was expected, the higher SG&A investment came as a surprise. It hired
~16,000 people in the past 12 months against just 8,800 in two years prior to
that. Employee utilisation, including trainees, has declined from 76% to 70% in
just four quarters. The company believes that SG&A investment will rise marginally
in Q2FY11, but productivity improvement will yield better gross margins. It expects
EBITDA margins to rise to 18.6% by June 2011 (same as June 2010), which, we
believe, can be achieved by improving utilisation as lateral hiring constitutes 77%
of gross employee addition in the past four quarters.
􀂃 Outlook and valuations: Margins need to improve; maintain ‘HOLD’
HCLT has delivered over 7% Q-o-Q revenue growth in constant currency terms
in each of the past three quarters. With 14 major deal wins in Q1FY11 and
mining of existing mid-sized accounts, we believe, the strong growth would
continue in the medium term. The recent strong hiring, especially high
proportion of laterals, is indicative of buoyant medium-term growth. Our only
concern is the significant decline in margins. While there are enough reasons to
believe that margins have bottomed out (likely pick up in utilisation, lower losses
in BPO), we believe, the consensus forecast for FY11 will have to be revised
down. We are cutting our FY11 earnings by 7% due to the company’s aggressive
SG&A spend, but maintain our FY12 forecast. At 17.9x FY11E (June year end)
and 13.9x FY12E earnings, we maintain ‘HOLD/Sector Performer’
recommendation on the stock.