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HCL Tech: Witnessing an uptick - Views on News from Equitymaster

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HCL Tech: Witnessing an uptick

Apr 22, 2010

HCL Tech has announced its FY10 results. The company has reported a 19% YoY and 2% YoY growth in sales and net profits respectively. Here is our analysis of the results.

Performance summary
  • Topline grows by 1% during 3QFY10 (financial year ends June). This was on the back of improved performance from the IT services business particularly the'Infrastructure services' business which witnessed an 11% QoQ growth during the quarter. Poorer performance of the BPO business however dented the overall performance.
  • Operating margins decline by 1.3% QoQ during the quarter mainly on account of 4% increase in direct cost.
  • Net profits grow by 16% QoQ during 3QFY10.
  • Adds 3,152 employees to IT services business during the quarter, taking the headcount to 58,129 by end of March 2010.
  • Declares an interim dividend of Re 1 per share.

Consolidated performance
(Rs m) 2QFY10 3QFY10 Change 9MFY09 9MFY10 Change
Sales 30,325 30,757 1.4% 76,999 91,396 18.7%
Expenditure 23,939 24,684 3.1% 60,201 72,049 19.7%
Operating profit (EBITDA) 6,386 6,073 -4.9% 16,798 19,347 15.2%
Operating profit margin (%) 21.1% 19.7%   21.8% 21.2%  
Other income (133) (141)   1,740 (337)  
Forex gain/(loss) (1,257) (626)   (4,195) (3,387)  
Depreciation 1,361 1,099 -19.3% 3,296 3,878 17.7%
Profit before tax 3,635 4,207 15.7% 11,047 11,745 6.3%
Tax 679 769 13.3% 1,608 2,150 33.7%
Minority interest & income of equity investee 12 1 -91.7% (2) 12  
Profit after tax/(loss) 2,968 3,439 15.9% 9,437 9,607 1.8%
Net profit margin (%) 9.8% 11.2%   12.3% 10.5%  
No. of shares (m)       670.4 691.3  
Diluted earnings per share (Rs)         18.7  
P/E ratio (x)*         19.1  
*On the basis of trailing 12 month; # financial year begins July

What has driven performance in 3QFY10?
  • HCL Tech recorded a sales growth of 1% QoQ during 3QFY10. This was largely due to higher demand for its 'infrastructure services' business which is a part of IT services segment. The company's IT services segment comprising of the core software business (70% of topline) and infrastructure services (22% of topline) grew by 3% QoQ on back of a 9% increase in volumes. Almost all of the incremental growth came from the infrastructure services business, which grew by 11% QoQ during the quarter. The core software services business grew by 0.5% QoQ. Sales from the BPO segment decline 13% QoQ, thus denting the otherwise good overall performance.

    Segment-wise sales performance
    In Rs m 2QFY10 3QFY10 Change
    Core Software 21,500 21,608 0.5%
    Infrastructure Services 6,143 6,816 11.0%
    BPO Services 2,682 2,333 -13.0%
    Revenue break-up by service offerings      
    Enterprise application system 6,793 6,582 -3.1%
    Engineering and R&D services 5,459 5,844 7.1%
    Custom Application (Industry Solutions) 9,249 9,196 -0.6%
    Infrastructure Management 6,156 6,828 10.9%
    BPO 2,669 2,338 -12.4%
    Revenue break-up by geography      
    US 17285 18300 5.9%
    Europe 8946 8212 -8.2%
    Asia Pacific 4094 4244 3.7%
    Revenue by Industry vertical      
    Financial services 7,915 7,843 -0.9%
    Manufacturing 7,763 8,212 5.8%
    Telecom 3,791 3,568 -5.9%
    Retail & CPG 2,426 2,307 -4.9%
    Media Publishing and Entertainment 2,183 2,430 11.3%
    Life Sciences 2,183 2,307 5.7%
    Energy-Utility & public sector 2,214 2,153 -2.7%
    Others 1,850 1,938 4.7%
    Source: Company

  • In terms of geographies, revenues from the US, HCL's major market, grew by around 6% QoQ. This formed around 60% to total revenues. Revenues from the Asia Pacific region also witnessed an increase of 4% QoQ. However, revenues from European markets declined by 8% QoQ. This was mainly on account of unfavourable cross currency movements.

  • HCL Tech's employee count stood at 58,129 at the end of March 2010. The company added a net of 3,152 employees during 3QFY10. Attrition level increased to 13.9% as against 12.8% witnessed during the previous quarter.

  • Operating margins declined by 1.3% during 3QFY10. This was mainly on account of increase in direct cost due to salary hikes. The currency fluctuations also impacted margins.

  • HCL Tech's net profits grew by 16% QoQ during the quarter. This was largely backed by favorable forex movement resulting in better hedge positions. Excluding the adjustment for forex losses from both the quarters, net profit declined by 4% QoQ.

What to expect?
At the current price of Rs 370, the stock is trading at a multiple of 15 times our estimated FY12 earnings. HCL Tech's management during the post results analyst conference call sounded upbeat about the company's performance during 3QFY10. It highlighted the company's achievements in the last 5 years since HCL Tech embarked on its organizational transformation. The company's topline and bottomline grew more than three and a half times over this period.

As for the current business environment, the management appeared quite sanguine on back of robust traction witnessed in key verticals and markets. The company is seeing a fair mix of 'running-the-business' (basic application outsourcing projects) and 'change-the-business' (transformational projects) kind of deals. Though cost cutting remains at the core of client's IT spending, there is some visible recovery in discretionary spending. However, the sustainability as well as growth of this spending will depend on the stability in the economic recovery being witnessed in client geographies.

The company is also believed to be benefitting from the churn of business from the hands of global IT majors to Indian players. HCL Tech's posted industry leading performance in verticals like manufacturing and consumer facing areas like media and retail. Its integration with Axon is paying results as the company has been able to increasingly cross-sell its services. However, large enterprise application deals are coming only in phases and revenue visibility in this regards seems to be lumpy. The company continues to invest in the transformation of its BPO business and expects to see a turnaround only after a couple of quarters. Going forward, while the margins are likely to be impacted by currency volatility and wage hikes, the management is confident that the company will continue to move ahead on a high growth trajectory.

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