HCL Technologies:: Growth investments delay margin rebound:: Nomura

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􀁾 Action
HCL Tech’s 1Q FY11 results indicate to us acceleration in growth momentum,
which would entail near-term investment in sales and hiring. We view these
investments positively in the long term and expect material operational benefits to
kick in, albeit with a one-quarter lag. HCL Tech remains our top large-cap IT pick
on better-than-peer group earnings growth and favourable valuations. BUY.
􀁡Catalysts
Fructification of HCL Tech’s better-than-ever deal pipeline will be the key near-term
trigger for the stock, in our view.
Anchor themes
Favorable positioning for successes in rebid scenarios, improving discretionary
demand, large IMS opportunity and HCL Tech’s large deal-winning prowess.



Growth investments delay margin
rebound
􀁣 Strong growth momentum continues
HCL Tech’s US$ revenue growth of 9% q-q was ahead of our
expectations and comparable to that of Infosys. Broad-based growth
was led by Europe (13.4% q-q), custom applications (12.9% q-q),
retail (11.2% q-q), and healthcare (10.5% q-q) in constant currency
terms.
􀁤 Deal pipeline best in company history
The company’s current deal pipeline is ~25% higher than during 1H
FY08 (subsequent to which HCL Tech won US$1bn of deals in 2Q
FY08). Fourteen large deal wins in 1Q FY11 and incremental
headcount growth of 10% q-q in IT services in our view point to a
robust demand scenario in the near term.
􀁥 Building a one-quarter lag on margin rebound
We are paring our FY11F EBITDA margin expectations on 1) higher
SG&A spending; 2) higher ESOP charges; and 3) lower-thanexpected
margin performance in 1Q FY11. We expect material margin
benefits to kick in starting 3Q FY11F on 1) ~630bp utilization scope;
and 2) 100-150bp from easing of growth investments.
􀁦 Compelling earnings growth, reiterate Buy
We expect Street concerns on margin declines and low quarterly cash
generation to be addressed through high operating leverage
(utilization scope, bulge mix and BPO revival) and an evening out of
cash generation over the year. Based on our estimates, HCL Tech’s
US$ revenue CAGR of 24.2% and EPS CAGR of 32.6% over FY10-
12F are better than those of its peers. We maintain our BUY rating
and PT of Rs510 (based on 16x one-year rolling forward earnings).