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HCL Tech: Continues the good run
May 2, 2014

HCL Technologies (HCL Tech) announced its second quarter (3QFY14) of financial year 2013-2014 (the company has a June year ending). The company reported a 2% QoQ growth in sales and an 8.6% QoQ increase in net profits. Here is our analysis of the results.

Performance summary
  • Consolidated net sales grew by 2% QoQ in 3QFY14 (The company has a June year ending).
  • However the growth in revenues was higher in US dollar terms at 3.0% QoQ.
  • Operating profits grew impressively by 5% QoQ while the operating margin improved to 26.7% as compared to 26% in the last quarter (2QFY14).
  • The net profit grew by a rapid pace of 8.6% QoQ. This was despite a forex loss of Rs 1,420 m.
  • Net employee count increased sequentially by 1,858 during the quarter. Total employee base at the end of March 2014 was 90,190. Attrition in the IT services business increased from 16.6% in 2QFY14 to 16.9% in 3QFY14. However, attrition in the BPO services business was flat sequentially at 5.8%.
  • The utilization rate for the company in the quarter stood at 84.2% compared to 84.1% in the previous quarter.

Consolidated Financial performance
(Rs m) 2QFY13 3QFY14 Change 9MFY13 9MFY14 Change
Sales 81,840 83,490 2.0% 205,488 244,940 19.2%
Expenditure 60,590 61,170 1.0% 156,562 180,440 15.3%
Operating profit (EBITDA) 21,250 22,320 5.0% 48,926 64,500 31.8%
Operating profit margin (%) 26.0% 26.7%   23.8% 26.3%  
Other income 1,110 1,350 21.6% 1,745 3,620 107.4%
Forex gain/(loss) (1,580) (1,420)   (2,314) (5,360)  
Depreciation 1,850 1,720 -7.0% 5,264 5,550 5.4%
Profit before tax 18,930 20,530 8.5% 43,093 57,210 32.8%
Tax 3,980 4,290 7.8% 9,649 11,860 22.9%
Minority interest - -   1 -  
Profit after tax/(loss) 14,950 16,240 8.6% 33,443 45,350 35.6%
Net profit margin (%) 18.3% 19.5%   16.3% 18.5%  
No. of shares (m)         699.4  
Diluted earnings per share(TTM) (Rs)         75.6  
P/E ratio (x)*         18.7  
*On the basis of trailing 12 month; # Financial year ends June

What has driven the performance in 3QFY14?
  • HCL Tech's sales growth of 2% QoQ was driven by a decent growth of 4.1% QoQ in the infrastructure services business segment. Also the enterprise applications business witnessed a growth of 2.6% QoQ.

  • The revenue growth between geographies was mixed with the US de-growing by 0.7% QoQ, Europe growing 3.6% QoQ while the rest of the world (RoW) saw good growth of 10.7% QoQ.

  • In terms of industry verticals, Energy-Utilities and public sector continued its good performance from the last quarter with a growth of 12% QoQ. This was followed by Financial Services which grew by 6.0% QoQ.

    Segment-wise performance
    (Rs m) 2QFY14 3QFY14 Change
    Revenue break-up by service offerings
    Enterprise application system 13,995 14,360 2.6%
    Engineering and R&D services 13,585 13,442 -1.1%
    Custom Application (Industry Solutions) 22,915 23,127 0.9%
    Infrastructure Management 27,580 28,721 4.1%
    BPO 3,765 3,757 -0.2%
    Revenue break-up by geography
    US  46,567 46,253 -0.7%
    Europe 25,616 26,550 3.6%
    RoW 9,657 10,687 10.7%
    Revenue by Industry vertical
    Financial services 21,197 22,459 6.0%
    Manufacturing 27,498 27,802 1.1%
    Telecom & Media 7,284 7,013 -3.7%
    Retail & CPG 7,038 7,097 0.8%
    Healthcare 8,757 8,683 -0.8%
    Energy-Utility & public sector 7,529 8,432 12.0%
    Others 2,537 1,920 -24.3%

  • In terms of operating performance, the operating margin improved by 0.7% QoQ largely due to a minor reduction in selling, general and administrative (SG&A) by Rs 50 m on a sequential basis.

  • At the net level, the operating performance was boosted by a 21.6% QoQ rise in other income and a 7% QoQ decline in depreciation. The net margin improved by 1.2% QoQ.
What to expect?
At the current price of 1,411 the stock of HCL Tech is trading at 18.7 times its trailing twelve month (TTM) EPS.

HCL Tech has had yet another good quarter in terms of both revenue growth and operating performance. This has been the tenth straight quarter with both, an increase in revenue growth and margin improvement in dollar terms. This can be almost completely attributed to the Infrastructure Management Services (IMS) business. IMS has grown by more than 5% on a sequential basis in the last four quarters. Leaving out this division, the company’s performance continues to remain average.

The company has seen a good number of deal wins in the quarter but the management does not provide specific numbers in this regard. However the overall deal pipeline continues to remain strong.

The management has stated that they have seen a pickup in discretionary spending in the US but not yet in Europe. Also US corporations have been faster adopters of new digital technologies compared to European ones. The company currently does not have a clearly articulated strategy for these new digital technologies. This does not give us any confidence that the company will be able to maintain its margins at the current levels. HCL Tech will need to invest significantly to build its capabilities in this space quickly, specifically if it wants to win large deals.

Considering the risk profile of the company especially the risks that it faces to its key growth engine, Infrastructure Management Services (IMS), as well as the completely over-stretched valuations, we maintain our Sell view on the stock.

We would like to gently remind our subscribers that their allocation to equities should be decided upon after keeping aside some safe cash. Also within their overall exposure to equities they should kindly ensure that our suggested asset allocation is broadly followed and that no single mid cap stock comprises more than 5% of their portfolio.

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