Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Demand risk ahead
Downgrade to REDUCE, significant risk to Street FY12-13 EPS
See demand deteriorating by late FY12, cut FY13E EPS by 25%
Margin comfort less now, weak demand could hurt
Heightened risk aversion could lead to valuation de-rating
Downgrade to REDUCE
We downgrade HCL Tech to REDUCE
(from Buy) and the Indian IT services
outlook to DETERIORATING. The stock
has declined 14% in August alone (vs a
7% drop in the Sensex), but we believe it
still does not reflect a likely prolonged
anaemic macro growth scenario nor the
50% chance of a US recession that our
economics team forecasts. HCL Tech has
consistently reported above-peer group
revenue growth in recent quarters and 20
new transformational deals signed in 4Q
suggest a strong revenue pipeline.
However, should the macro environment worsen as we expect it to, we
would not be surprised to see delays in deal ramp-ups. Moreover, the
4QFY11 results have effectively ended Street’s hopes of continued
margin expansion in FY12. In fact, we believe that likely pricing pressure
and delays in project starts may actually lead to a further decline in HCL
Tech’s already lower-than-peers EBIT margin in FY13. This and our 14%
revenue cuts lead to our 25% EPS downgrade for FY13.
Transformation yes, but margin issue needs addressing
HCL Tech is undergoing a positive long-term transformation. After the
revamp of its BPO business in 2012, the company will likely have the
most balanced portfolio among peers with a healthy mix of enterprise
solutions, applications, infrastructure services, and engineering services.
About 28% of revenue now comes from focus verticals such as media
and life sciences (vs 17% in FY07) and this has helped offset persistent
telecom revenue weakness. Further, the company has reduced its client
concentration risk (top-10 clients contribute 35% of revenue, vs 51% in
FY07). However, after the dip in FY11, HCL Tech's EBIT margin is 8-
16ppt below peers’. Therefore, growth has come at a price and possible
pricing pressure ahead could further alter HCL Tech’s margin profile.
Valuation and target price derivation
Given heightened macro uncertainty and risk aversion, we expect the
stocks to trade significantly below the level implied by our DCF model
based on long-term average risk assumptions. In 2008, large-cap Indian
IT stocks fell as much as 40-65% below our fair value estimates, so we
set our TP for HCL Tech at a 25% discount to our DCF value. Our new
TP implies an FY13E P/E of 9.9x. Key risks to our TP are: 1) unexpected
USD/INR depreciation (as seen in 2008-09) that negates our EPS cuts
and 2) less-than-expected deterioration of the macro environment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Demand risk ahead
Downgrade to REDUCE, significant risk to Street FY12-13 EPS
See demand deteriorating by late FY12, cut FY13E EPS by 25%
Margin comfort less now, weak demand could hurt
Heightened risk aversion could lead to valuation de-rating
Downgrade to REDUCE
We downgrade HCL Tech to REDUCE
(from Buy) and the Indian IT services
outlook to DETERIORATING. The stock
has declined 14% in August alone (vs a
7% drop in the Sensex), but we believe it
still does not reflect a likely prolonged
anaemic macro growth scenario nor the
50% chance of a US recession that our
economics team forecasts. HCL Tech has
consistently reported above-peer group
revenue growth in recent quarters and 20
new transformational deals signed in 4Q
suggest a strong revenue pipeline.
However, should the macro environment worsen as we expect it to, we
would not be surprised to see delays in deal ramp-ups. Moreover, the
4QFY11 results have effectively ended Street’s hopes of continued
margin expansion in FY12. In fact, we believe that likely pricing pressure
and delays in project starts may actually lead to a further decline in HCL
Tech’s already lower-than-peers EBIT margin in FY13. This and our 14%
revenue cuts lead to our 25% EPS downgrade for FY13.
Transformation yes, but margin issue needs addressing
HCL Tech is undergoing a positive long-term transformation. After the
revamp of its BPO business in 2012, the company will likely have the
most balanced portfolio among peers with a healthy mix of enterprise
solutions, applications, infrastructure services, and engineering services.
About 28% of revenue now comes from focus verticals such as media
and life sciences (vs 17% in FY07) and this has helped offset persistent
telecom revenue weakness. Further, the company has reduced its client
concentration risk (top-10 clients contribute 35% of revenue, vs 51% in
FY07). However, after the dip in FY11, HCL Tech's EBIT margin is 8-
16ppt below peers’. Therefore, growth has come at a price and possible
pricing pressure ahead could further alter HCL Tech’s margin profile.
Valuation and target price derivation
Given heightened macro uncertainty and risk aversion, we expect the
stocks to trade significantly below the level implied by our DCF model
based on long-term average risk assumptions. In 2008, large-cap Indian
IT stocks fell as much as 40-65% below our fair value estimates, so we
set our TP for HCL Tech at a 25% discount to our DCF value. Our new
TP implies an FY13E P/E of 9.9x. Key risks to our TP are: 1) unexpected
USD/INR depreciation (as seen in 2008-09) that negates our EPS cuts
and 2) less-than-expected deterioration of the macro environment.
No comments:
Post a Comment