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HCL Technologies: Inorganic growth

Apr 23, 2002

HCL Technologies’ inorganic growth model is paying off. The company for 3QFY02 posted a 2% sequential rise in topline. However, the rise in net profits has been steeper at 6% based on a significant rise in other income.

(Rs m)2QFY023QFY02Change9mFY019mFY02Change
Other Income37348830.8% 921 1,324 43.8%
Expenditure2,9483,0463.3% 7,149 8,760 22.5%
Operating Profit (EBDIT)1,0651,044-2.0%3,0463,0670.7%
Operating Profit Margin (%)26.5%25.5% 29.9%25.9% 
Interest - -   - -  
Depreciation1441536.3% 298 40034.2%
Profit before Tax1,2941,3796.6%3,6693,9918.8%
Extra-ordinary item -   90 (240)-366.7%
Stock based sales incentive expense/ (income)256-76.0% - 11 
Tax386160.5% 275 218-20.7%
Profit after Tax/(Loss)1,2311,3126.6% 3,484 3,522 1.1%
Net profit margin (%)30.7%32.1% 34.2%29.8% 
Diluted number of shares (m)285.4285.4 285.4285.4 
Diluted Earnings per share* 17.3 18.4   16.3 16.5  
P/E (x)  13.8    15.4  

The company’s operating margins have headed south during the quarter. This could be due to the lower realisations on the back of intense pricing pressure the software sector has been witnessing. In 3QFY02, HCL Tech saw onsite billing rates decline by 2% sequentially, while the offshore billing rates declined by 3%.

For the 9mFY02 the company posted a 16% rise in topline. However, the fall in operating margins and a write off in 1QFY02, have taken a toll on the company’s bottomline. The net profits have improved by a marginal 1%. The write off amounting to Rs 240 m in 1QFY02 was for doubtful debts and diminution in the value of investments.

Service offerings2QFY023QFY02Change
 (Rs m)% Contribution(Rs m)% Contribution 
Technology development services 789 44% 644 37.3%-18.4%
Networking 241 13% 271 15.7%12.7%
S/W Product Engineering 257 14% 261 15.1%1.4%
Applications 482 27% 482 27.9%0.1%
BPO 23 1% 68 4.0%196.2%

The topline growth for the quarter came from the company’s networking and IT enabled service offerings. The technology development service that caters to technology companies mostly from the telecom space saw a steep 14% sequential decline in revenues. The contribution from offshore revenues to the total revenues was 68% with the remaining 32% coming from onsite projects.

During the quarter the company added 21 new clients (22 in 2QFY02). The total number of clients added so far in 9mFY02 has been 63. The number of active clients for the company stands at 346. In 3QFY02, HCL Tech also formed joint ventures with Answerthink, a US based provider of technology-enabled business transformation solutions and Zamba Solutions, a US based CRM solutions consulting and systems integration company. The company added two new client dedicated ODCs (offshore development centre) during the quarter. This takes the total number of ODCs to 47.

HCL Tech saw strong sequential growth in revenues from the European geography. While the revenues from the US grew in line with the topline growth (2%), the revenues from the Asia Pacific region declined sequentially.

Standalone numbers
HCL Technologies (standalone) has posted a 4% decline in topline for 3QFY02. However, the other income has helped the company post a flat bottomline, inspite of operating margins deteriorating.

(Rs m)2QFY023QFY02Change9mFY019mFY02Change
Sales1,7911,726-3.6% 5,359 5,298 -1.1%
Other Income 337 454 35.0% 744 1,179 58.4%
Expenditure9871,0445.7% 2,573 2,957 14.9%
Operating Profit (EBDIT)804683-15.1% 2,786 2,341 -16.0%
Operating Profit Margin (%)44.9%39.5% 52.0%44.2% 
Interest - 1   - 1  
Depreciation 78 90 15.7%156 245 57.1%
Profit before Tax1,0631,046-1.6%3,3743,273-3.0%
Tax 51 33 -36.6%198 161 -18.7%
Profit after Tax/(Loss)1,0121,0140.2%3,1763,113-2.0%
Net profit margin (%)56.5%58.7% 59.3%58.7% 
Diluted number of shares285.4285.4 285.4285.4 
Diluted Earnings per share* 14.2 14.2   14.8 14.5 
P/E (x)   17.8    17.4  

HCL Technologies’ business model is such that it earns a significant other income from its investment in other companies. On a YoY basis the company’s revenues for 3QFY02 have decline by 9% and the drop in net profits is 10%.

At the current market price of Rs 253, the stock is trading at 18x its 3QFY02 annualised earnings. The strong growth in revenues from IT enabled services is likely to catch the markets fancy sooner or later. This could result in valuations heading north.

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