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HCL Tech: Conference call excerpts - Views on News from Equitymaster
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HCL Tech: Conference call excerpts
Feb 12, 2010

We recently had a conference call with the management of HCL Technologies, India’s fourth largest IT services exporter in order to discuss the company’s 2QFY10 performance. Besides discussing the drivers of performance during 2009 amidst global recession, the management also highlighted HCL Tech’s long term strategy post recession. The following are the key takeaways of the conference call. A year of ups and downs:

The management reiterated the fact that the year of 2009 had been filled with challenges and immense learning. Considering that the full integration of Axon in its accounts happened in 3QFY09 (i.e. January –March 2009), the management discussed the performance for HCL over the last 3 quarters. On an aggregate basis the company saw a revenue growth of 5% over the last three quarters. However, it made some interesting observations in terms of service offerings. The major growth drivers for the company over the period were plain vanilla custom applications and infrastructure services which witnessed a cumulative growth of 8% and 16% respectively for last three quarters of CY09. Higher end services in the enterprise solutions and engineering and R & D segment witnessed muted performance. While the former grew by around 2% YoY during last three quarters, the latter declined by the same percentage.

However, what is more interesting is the trend that the management read in between these numbers. It highlighted that during the mid of 2009, when the recession was supposedly at its worst, the lower-end IT services like application development and maintenance and infrastructure management bolstered revenue growth. These services were offered to clients as a bundle, resulting in a good demand. The customers were in “run-the-business” mode then. The higher end services in enterprise solutions and R&D domain which were the growth drivers pre-recession, performed rather weakly during the peak recession. Nevertheless, the trend appears to have shifted again in the last quarter. High end services are witnessing a turn-around and are expected to catalyse major improvement in terms of volumes and incremental growth going forward. Post recession the lower end services will return to their historical levels, continuing to contribute major chunk of company’s revenue.

A similar trend is being witnessed in the industry verticals as well. The banking and financial services (BFS) industry which is a major contributor to all the Indian IT companies maintained its dominant share. For HCL Tech, this vertical grew by 9% during last three quarters of 2009. Manufacturing vertical remained plagued by recession all through and is witnessing a lagged recovery lately. The verticals that drove much of the incremental gains were retail, media and publishing and life sciences. Before the recession, the company focused on the mega-verticals of BFS and manufacturing as they were huge and major growth drivers. However during recession focused on micro-vertical which fructified as incremental growth in niche sectors. The management hinted that post recession it will reemphasize its focus on manufacturing and financial services.

The company’s BPO segment that appears as a cause of concern is actually undergoing a strategic shift. It may be noted that this business has been declining off-late and witnessed a weak growth of just 0.7% during last 3 quarters of CY09. Here the company previously focused on voice-based contact-center type of services. Nevertheless, now it is aiming to change its BPO service-mix. The new focus will 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.

What to expect?

At the current price of Rs 349, the stock is trading at a multiple of 12.9 times our estimated FY12 earnings. Though there appears some green shoots of recovery for the IT sector, it will be a while before discretionary spending and mega-deals come back to the table. The recovery is expected to be lagged in major markets of US and Europe.

Despite being one of the largest players from the Indian IT sector, the stock has always traded at a good discount to the top three companies. Now, despite a strong technology portfolio, the most important reason for these lower valuations is the concern regarding the company's management that has made some shareholder unfriendly acquisitions in the past. As such, despite the stock's low valuations, we have a cautious view on the same.

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