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HCL Tech: Muted performance - Views on News from Equitymaster

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HCL Tech: Muted performance

Jan 28, 2010

Performance summary
  • Topline remains flat during 2QFY10 (financial year begins July) on the back of muted performance in major segments like financial services and manufacturing particularly in the US market.
  • Operating margins contract by 1.6% QoQ during the quarter mainly on account of weak topline and increase in expense primarily due to wage hikes. Currency fluctuation also impacted margins.
  • Net profits declined by 7.3% QoQ during 2QFY10. Profits for the quarter were impacted by decline in margins, extraordinary losses on cash flow hedges and a lower other income.
  • Adds 1,691 employees to IT services business during the quarter, taking the headcount to 55,688 by end of 2QFY10.
  • Declares an interim dividend of Re 1 per share.

Consolidated performance
(Rs m) 1QFY10 2QFY10 Change 1HFY09 1HFY10 Change
Sales 30,314 30,325 0.0% 48,601 60,639 24.8%
Expenditure 23,426 23,939 2.2% 37,689 47,365 25.7%
Operating profit (EBITDA) 6,888 6,386 -7.3% 10,912 13,274 21.6%
Operating profit margin (%) 22.7% 21.1%   22.5% 21.9%  
Other income (63) (133)   1,764 (196)  
Forex gain/(loss) (1,504) (1,257)   (2,393) (2,761) 15.4%
Depreciation 1,418 1,361 -4.0% 1,879 2,779 47.9%
Profit before tax 3,903 3,635 -6.9% 8,404 7,538 -10.3%
Tax 702 679 -3.3% 1,123 1,381 23.0%
Minority interest & income of equity investee (1) 12   (14) 11 -178.6%
Profit after tax/(loss) 3,200 2,968 -7.3% 7,267 6,168 -15.1%
Net profit margin (%) 10.6% 9.8%   15.0% 10.2%  
No. of shares (m) 685.0 689.6   670.4 689.6  
Diluted earnings per share (Rs)         16.9  
P/E ratio (x)*         19.5  
*On the basis of trailing 12 month; # Financial year begins July

What has driven performance in 2QFY10?
  • HCL Tech recorded an almost flat quarter in terms of sales during 2QFY10. This was largely on account of muted performance of the company’s engineering, R&D services and BPO businesses, particularly in the US market. It’s IT services segment comprising of the core software business (71% of topline) and the infrastructure services (20% of topline) grew by 1% QoQ. This was on the back of improvement in volumes and favorable currency movement. Much of the incremental growth came from the infrastructure services business, which grew by 20% QoQ during the quarter. The core software services business grew by 2% QoQ during 2QFY10. The BPO segment (9% of the topline) recorded a decline of 5% QoQ during the quarter. Its enterprise solutions business maintained a positive growth.

  • As regards industry verticals, HCL Tech recorded a decline of 7% and 1% QoQ respectively in manufacturing and banking & financial services (BSF) segments. These are the company’s major segments which contribute over 25% each its topline. The telecom segment (13% of sales) witnessed a drop of 4% QoQ. Media publishing and entertainment vertical (7% of sales) grew by a robust 6% QoQ. Retail (8% of sales) and life-sciences (7% of sales) businesses grew by 14% and 13% QoQ respectively.

    In Rs m 1QFY10 2QFY10 Change
    Core Software 21,148 21,500 1.7%
    Infrastructure Services 5,130 6,143 19.7%
    BPO Services 2,806 2,682 -4.4%
    Revenue break-up by service offerings      
    Enterprise application system 6,639 6,793 2.3%
    Engineering and R&D services 5,669 5,459 -3.7%
    Custom Application (Industry Solutions) 9,306 9,249 -0.6%
    Infrastructure Management 5,881 6,156 4.7%
    BPO 2,819 2,669 -5.3%
    Revenue break-up by geography      
    US 17794 17285 -2.9%
    Europe 8791 8946 1.8%
    Asia Pacific 3729 4094 9.8%
    Revenue by Industry vertical      
    Financial services 7,973 7,915 -0.7%
    Manufacturing 8,306 7,763 -6.5%
    Telecom 3,941 3,791 -3.8%
    Retail & CPG 2,122 2,426 14.3%
    Media Publishing and Entertainment 2,061 2,183 5.9%
    Life Sciences 1,940 2,183 12.5%
    Energy-Utility & public sector 2,061 2,214 7.4%
    Others 1,910 1,850 -3.1%

  • In terms of client geography, revenues from the US, HCL’s major market, declined by around 3% QoQ, contributing around 57% to total revenues. Nevertheless, the company recorded some traction from the Asia Pacific and the European geographies during 2QFY10. Business from Europe and Asia Pacific regions grew by 6% and 2% respectively.

  • HCL Tech’s employee count stood at over 55,688 at the end of December 2009. The company added a net of 1,691 employees during 2QFY10. Attrition level was at 12.8% at the end of the quarter.

  • Operating margins contracted by 1.6% during 2QFY10. This was mainly on account of salary hikes and currency fluctuations.

  • HCL Tech’s net profits declined by 7.3% QoQ during the quarter. Huge amount of unfavorable forex movement coupled with increase in expenses impacted the bottom-line decline. Excluding the adjustment for these forex losses from both the quarters, the net profit still declined by 9% QoQ, indicating a weakness in overall financial performance.

What to expect?
At the current price of Rs 330, the stock is trading at a multiple of 12.2 times our estimated FY12 earnings. During the conference call, HCL Tech’s management highlighted that though the topline performance appears muted in rupee terms, in dollar terms, the company saw a growth of 4% QoQ. However, the currency fluctuation during the quarter impacted its rupee revenues as well as margins. The management sounded cautious about the pace of recovery in the US. It indicated that the BPO segment that appears as a cause of concern is actually undergoing a strategic shift. The company, which previously focused on voice-based contact-center type of services, is aiming to change its BPO service-mix. The new focus will now be on non-voice based critical and strategic services. However, this change will require some time and BPO revenues will remain stretched in the short-term.

Nevertheless, the management appeared confident of its strategy during the recession. Its focus on micro-verticals providing niche services for retail, media and BFS verticals helped it combat the downturn. It also remains confident of the future growth. It believes the discretionary IT spending which saw a sudden fall during recession will see a significant pick-up in the second half of 2010. It believes that business segments like enterprise services and BPO and verticals like BFS, manufacturing and telecom will continue to drive growth in the post-recession period.

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