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HCL Tech: Core software leads way - Views on News from Equitymaster

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HCL Tech: Core software leads way

Apr 16, 2008

Performance summary
  • Topline grows by 7% QoQ in 3QFY08 (June ending fiscal) on back of good performance from the core services business, where sales growth stood at 8.4% QoQ.
  • Operating margins expanded marginally by 0.9% QoQ during the quarter. Higher employee utilisation levels, increased offshore share in revenues and lower SG&A costs (as percentage of sales) aid this expansion.

  • Net profits grow by 3% QoQ during 3QFY08. Growth largely impacted by a decline in other income.

  • Adds a net of 1,848 employees during the quarter; attrition rate for IT services declines to 15.2%, from 15.5% in 2QFY08.

  • Recommends a dividend of Rs 2 per share (dividend yield of 0.8%).

Financial performance: A snapshot…
(Rs m) 2QFY08 3QFY08 Change 9MFY07 9MFY08 Change
Sales 18,166 19,448 7.1% 44,217 54,706 23.7%
Expenditure 14,281 15,117 5.9% 34,320 42,851 24.9%
Operating profit (EBITDA) 3,885 4,331 11.5% 9,897 11,855 19.8%
Operating profit margin (%) 21.4% 22.3%   22.4% 21.7%  
Other income 542 228 -58.0% 1,386 1,274 -8.1%
Depreciation 724 773 6.8% 1,839 2,183 18.7%
Profit before tax 3,704 3,786 2.2% 9,444 10,947 15.9%
Tax 355 368 2.5% 708 1,069 50.9%
Minority interest & income of equity investee 21 (7)   54 42 -23.0%
Profit after tax/(loss) 3,329 3,425 2.9% 8,682 9,837 13.3%
Net profit margin (%) 18.3% 17.6%   19.6% 18.0%  
No. of shares (m)         679.1  
Diluted earnings per share (Rs)         21.7  
P/E ratio (x)         12.1  

What has driven performance in 3QFY08?
  • HCL Tech recorded a 7% QoQ growth in topline during 3QFY08. This growth was largely driven by the core software business, which grew its sales by 8% QoQ. The other two segments of infrastructure service and BPO recorded sales growth of 3.3% QoQ and 3.7% QoQ respectively. Within the core software segment, the custom application services (51% of the segments’ revenues) has been the lead growth driver with sales rising by 9.4% QoQ. Following this is the engineering and R&D services segment (35% of core software revenues), which has recorded a sales growth of 9.2% QoQ during 3QFY08.

    Based on industry verticals, HCL Tech has recorded the best performance in the ‘hi-tech’ vertical, which provides technology solutions for semiconductor and chip design. This vertical recorded sales growth of 11% QoQ during 3QFY08. The other verticals the performed well were telecom (9% QoQ) and financial services (4% QoQ). Retail and media spaces, however recorded marginal growth rates of 2% QoQ and 3% QoQ respectively.

    Segmental performance
    (Rs m) 2QFY08 3QFY08 QoQ Change
    Core Software      
    Revenue 13,199 14,309 8.4%
    % of revenues 72.7% 73.6%  
    EBITDA margins 21.6% 22.5%  
    Infrastructure Services      
    Revenue 2,783 2,875 3.3%
    % of revenues 15.3% 14.8%  
    EBITDA margins 16.8% 18.0%  
    BPO Services      
    Revenue 2,184 2,265 3.7%
    % of revenues 12.0% 11.6%  
    EBITDA margins 26.0% 26.1%  

  • During 3QFY08, HCL Tech added a net of 1,848 employees to its rolls, thus taking the total strength to 49,800 at the end of March 2008. Incidentally, a large part of the net addition came through in the BPO segment while IT services actually witnessed a net decline of 97 employees. However, the company achieved success in controlling attrition within this segment, with the same coming down to 15.2% (from 15.5% in 2QFY08). On the clientele front, HCL Tech added a net of 13 new clients during 3QFY08.

  • HCL Tech’s operating margins expanded by 0.9% QoQ during the quarter, mainly due factors like higher employee utilisation levels, increased offshore share in revenues and lower SG&A costs (as percentage of sales). The 1% depreciation of the rupee against the US dollar during 3QFY08 has also helped HCL Tech improve its profitability.

  • HCL Tech’s net profits grew by 3% QoQ during 3QFY08. This was way lower than the growth recorded in net sales, and was largely a result of lower other income during the quarter (58% QoQ decline).

What to expect?
At the current price of 262, the stock is trading at 12.1 times its trailing 12 months earnings. While the management has indicated of some kind of slowdown in tech spending over the next two quarters (in line with what Infosys’ management has indicated), it also expects the momentum to remain strong from a medium to long-term perspective, simply because of the cost benefit advantage of offshore outsourcing.

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