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HCL Technologies
Time to reap
„Highest rev growth; Operating leverage to kick in; Buy
HCL Tech’s 2Q GAAP revenue, EBIT and PAT in INR terms was 1, 7 and 9%
ahead of our estimate, helped by 62bps EBIT margin beat. It reported an industry
leading 7.5% qoq growth in USD terms revenue led by growth across services
and verticals. Margins are expected to expand next two quarters helped by
operating leverage and some price increases. We raise EPS ests. by 3-4%.
Reiterate Buy, PO of Rs620 implying a reasonable 15xFY13. See trigger in our
estimated 30% revenue and 19% EBIT yoy growth in H2FY11, as compared to
25% and -6% in H1, respectively. FY12 EBIT growth forecast at 31%.
All round rev growth; Margins bottom
In INR terms, revenue grew 5% qoq and 28% yoy, led by volume growth, in
infrastructure management services (IMS) & custom application services. Among
verticals while retail and energy/utilities stole the show with 14-15% qoq growth,
the other verticals also showed steady growth as well. EBIT margins expanded
sequentially by 25bps helped by transition related ramp costs being behind in
IMS, SG&A leverage in software and lower BPO losses, as rev kicked in. EBIT
grew 7% qoq, it grew merely 1% yoy, on wage hikes, hiring and BPO losses.
Profits grew 21% qoq and 35% yoy helped by lower forex related hedging losses.
Operating leverage to drive strong earnings growth ahead
We have built in a 180bps sequential improvement in margins over 2Q to 4QFY11
and 100bps margin expansion in FY12, driven by higher utilization, continued
SG&A optimization and some inflation-related price increases. BPO investments
are likely to be done by H1FY12. As HCLT executes on the strong order booking
in last few quarters, including 17 large deals this quarter, it is set to benefit from
operating leverage, post the healthy hiring in previous two quarters. Attrition down
300bps to 18% quarterly annualized in IT services.
Time to reap
HCL Tech’s 2Q GAAP revenue, EBIT and PAT in INR terms was 1, 7 and 9%
ahead of our estimate. It reported an industry leading 7.5% qoq growth in USD
terms revenue led by growth across services and verticals.
Margins are expected to expand next two quarters helped by operating leverage
and some price increases. We estimate H2FY11 to reflect 30% revenue growth
and 19% EBIT growth yoy, as compared to 25% and -6% in H1, respectively.
FY12 EBIT growth forecast at 31%.
Reiterate Buy, PO of Rs620 implying almost 15xFY13. We believe this is justified
as it implies a conservative FY12 EV/EBITDA to 2yr EBITDA growth (EEG) of
0.5x, a discount of over 30% to Wipro' s target EEG. Our target PE is at over 30%
discount to Infosys target PE, which we believe is fair given half the margins. We
expect earnings growth to drive the stock.
We see the highest potential stock upside in HCLT amongst the large cap IT
service vendors led by a FY11-13e EBITDA CAGR of 31%, driven by its exposure
to discretionary IT services like enterprise solutions, high growth infrastructure
management services (IMS) and likely margin uptrend from March as
investments pay off.
2Q highlights
„ Rev CQGR at 7.5% over past four quarters is the highest amongst the top 4
vendors.
„ Strong deal signings with 17 transformational project wins. Outlook on
client budgets positive for CY11, similar to commentary to Infy and TCS.
Other Highlights
„ Dividend pay-out increased to INR2 for the quarter vs. INR1.5 last quarter.
„ Operating cash flow saw an improvement on normalizing of the aberration
caused by a large Systems integration deal last quarter.
„ DSO (including unbilled revenues) declined to 77days vs 80 days last qtr.
Other margin levers
„ BPO investments in transitioning from voice to non-voice business to be
done this calendar year. All investments being written off, and we believe it
will be restricted to a further USD25m.
„ If Enterprise Solutions shows greater than expected traction, Axon and
hence software margins can lend upside. HCLT has been named leader in
SAP Implementation service providers by Gartner, Forrester and IDC.
Price objective basis & risk
HCL (XHCLF)
Our Price Objective of Rs620 assumes a one-year forward FY13e P/E of nearly
15x as margins bottom. We believe this is justified as it implies a conservative
FY12 EV/EBITDA to 2yr EBITDA growth (EEG) of 0.5x, a discount of over 30% to
Wipro' s target EEG. Downside risks stem from higher than expected investments
delaying margin recovery, macro led delays in discretionary IT spending, higher
than expected wage hike pressures and Rupee appreciation.
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