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HCL Tech: A poor performance - Views on News from Equitymaster
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HCL Tech: A poor performance
Apr 27, 2015

HCL Technologies (HCL Tech) announced its third quarter (3QFY15) of financial year 2014-2015 (the company has a June year ending). The company reported a 0.2% QoQ fall in sales and a 12.1% QoQ fall in net profits. Here is our analysis of the results.

Performance summary
  • Consolidated sales fell by 0.2% QoQ in 3QFY15. In constant currency terms sales were flat sequentially.
  • Operating profits decreased by 9.8% QoQ. The operating margin fell steeply to 22.6% in 3QFY15 as compared to 25% 2QFY15. This was due to the poor topline performance as well as a 6% QoQ increase in SG&A costs.
  • The other income fell by 2% QoQ while depreciation increased 3.7% QoQ.
  • The consolidated net profit fell by 12.1% QoQ largely due to the poor operating performance.
  • The company has declared an interim dividend of Rs 4 per share to be paid out on 05 May 2015.

Consolidated financial performance
(Rs m) 2QFY15 3QFY15 Change 9MFY14 9MFY15 Change
Sales 92,830 92,670 -0.2% 244,940 272,850 11.4%
Expenditure 69,640 71,760 3.0% 180,440 206,830 14.6%
Operating profit (EBITDA) 23,190 20,910 -9.8% 64,500 66,020 2.4%
Operating profit margin (%) 25.0% 22.6%   26.3% 24.2%  
Other income (net of finance costs) 2,010 1,970 -2.0% 3,620 7,560 108.8%
Forex gain/(loss) 150 (180)   (5,360) (560)  
Depreciation 1,090 1,130 3.7% 5,550 3,260 -41.3%
Profit before tax 24,260 21,570 -11.1% 57,210 69,760 21.9%
Tax 5,100 4,730 -7.3% 11,860 15,020 26.6%
Minority interest 10 2 -82.0% - 22  
Profit after tax/(loss) 19,150 16,838 -12.1% 45,350 54,718 20.7%
Net profit margin (%) 20.6% 18.2%   18.5% 20.1%  
No. of shares (m)            1,405.7  
Diluted earnings per share (TTM)         53.0  
P/E ratio (x)*         16.7  
* trailing 12 month earning

What has driven the performance in 3QFY15?
  • In terms of the performance metrics, HCL Tech delivered a muted performance across several parameters growth was impacted by client specific vendor consolidation issues in the European retail vertical.

    Segment-wise performance
    (Rs m) 2QFY15 3QFY15 Change
    Revenue break-up by service offerings
    Enterprise Application Services 14,296 13,159 -8.0%
    Engineering and R&D services 16,988 17,515 3.1%
    Industry Application  Services 25,064 25,299 0.9%
    Infrastructure Management Services 31,934 31,971 0.1%
    BPO 4,549 4,726 3.9%
    Revenue break-up by geography
    US  53,284 53,285 0.0%
    Europe 29,427 28,728 -2.4%
    RoW 10,118 10,657 5.3%
    Revenue by industry vertical
    Financial services 24,693 24,187 -2.0%
    Manufacturing 30,541 30,952 1.3%
    Telecom & Media 7,798 8,340 7.0%
    Retail & CPG 9,005 7,784 -13.6%
    Healthcare 10,304 10,379 0.7%
    Energy & Public Sector 8,819 9,638 9.3%
    Others 1,671 1,390 -16.8%

  • The operating performance was impacted in the quarter due to investments made in expanding existing centers as well as opening a couple of co-innovation labs with key clients. More onsite investments can be expected going forward.

  • At the net level, the sequential fall in operating margins and the sequential fall in the other income weighed heavily on the bottomline. The net profit fell by 12.1% QoQ.
What to expect?
At the current price of 883 the stock of HCL Technologies is trading at 16.7 times its trailing twelve month earnings.

The sequential rise in the US dollar against major global currencies weighed heavily on the topline. However, the company did not have a great quarter otherwise either. The management has stated that the demand environment continues to remain strong but the company continues to face client specific issues across verticals with regards to pricing of traditional services.

As far as the margins are concerned, we believe that it will be extremely difficult for the company to even maintain the net margin at these levels going forward. The management's stated objective is to maintain EBIT margins in a tight band of 21-22% (excluding cross currency impact). It must be pointed out that the company will have to invest significantly in training as well as developing IP (which has not been its strength historically) going forward.

While the company is in fine shape from a balance sheet perspective, growth is clearly slowing down. Along with slowing growth, the company will remain in investment mode for the foreseeable future. The management is yet to articulate a viable long term strategy concerning newer digital technologies despite diverting large investments into this space.

While the long term fundaments of the company are sound, we remain unconvinced about the growth prospects as well as the margins going forward. Keeping these factors in mind, we reiterate our view that investors should not buy the stock at these levels.

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