UBS:: HCL Technologies- Likely to be less defensive

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UBS Investment Research
HCL Technologies
L ikely to be less defensive [EXTRACT]
􀂄 Infrastructure services less likely to be impacted by slowdown
HCL Technologies (HCLT) continues to grow its infrastructure services business,
adding significantly to its growth. In FY11 the business contributed 23% of
revenue, up from 15% in FY08. We believe infrastructure services will remain
relatively strong and is less likely to be impacted by a potential economic
slowdown. This should compensate to some extent for the likely weakness in
enterprise solutions (21% of revenue) and potential delay in business process
outsourcing (BPO) turnaround.
􀂄 Margin profile likely to remain lower
The recovery in margins in H2 FY11 after the steep plunge in H2 FY10 and H1
FY11 is now fully factored in, with consensus estimates expecting flat margins in
FY12. We expect margins to remain under pressure due to its dependence on more
experienced employees and lower pricing power relative to peers.
􀂄 Stock likely to be less defensive in a downturn
In the 2008 recession, HCLT dipped to a 40% discount to Infosys (its historical
average is 28%) as investors fled to large cap stocks with strong balance sheets and
return ratios. While HCLT’s balance sheet has improved over the past few
quarters, we believe the valuation discount to its larger peers would expand in a
sectoral downtrend.
􀂄 Valuation: maintain Sell rating; cut price target from Rs430 to Rs380
HCLT is trading at a 20% PE discount to Infosys, compared to its historical
average of 28%, which we believe is unjustified. We derive our price target from a
DCF-based methodology and explicitly forecast long-term valuation drivers using
UBS’s VCAM tool. Our price target assumes a 12.9% WACC, and terminal
growth of 3%.


􀁑 HCL Technologies
HCL Tech is a leading Indian IT Services company with US$2.2bn revenue and
around 55,000 employees in FY09. The company focuses on technology and
R&D outsourcing and provides technology development services (development,
redevelopment and maintenance of software); enterprise application services;
infrastructure services; and BPO.
􀁑 Statement of Risk
We believe the continuing negative newsflow in developed economies is likely
to impair 2012 budgets and pose significant downside risk to our earnings
estimates in the near term. Appreciation of the Indian rupee against major global
currencies could also impact profitability for the company.