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HCL Tech: Volume growth would be the focus
Jul 28, 2011

HCL Technologies Ltd (HCL Tech) has announced the fourth quarter results of financial year 2010-2011, ended June 2011 (4QFY11). The company has reported a 5.5% QoQ and 10.7% QoQ growth in sales and net profits respectively. Here is our analysis of the results.

Performance summary
  • Net sales grew by 5.5% QoQ in 4QFY11 (The company has a June year ending). This was driven by the growth across all geographies and service offerings except in BPO service offerings. The company witnessed a 4.3% growth in volume. For the year ended June 2011, sales grew by 26.2% YoY.
  • Operating margins improved by 1.2% QoQ to 18.5% during the quarter as compared to 17.3% seen during the previous quarter (quarter ended March 2011, 3QFY11). This was mainly due to lower direct costs and 'Selling, General and Administration' expenses (both as a percentage of sales). However, for the full year FY11, operating margins declined to 17.1% from the 20.5% seen for the same period last year.
  • Added 3,949 (net) employees during the quarter. Total employee base at the end of June 2011 was 77,046. Attrition rate came down to 16.5% as compared to 17.0% seen at the end of the previous quarter (3QFY11).
  • Net profit grew by 10.7% QoQ during the quarter. This was largely driven by higher margins at operating levels during the quarter. For the full year FY11 (year ended June 2011), net profits increased by 29.9% YoY. This was mainly driven by the growth in revenues and other income, which offset the impact of higher tax rates during the year.
  • Added 70 new clients during the quarter. The total number of active clients at the end of June 2011 was 467.
  • Proposed a final dividend of Rs 2 per share. Including this total dividend for the year would be Rs 7.5 per share (yield of 1.5%)

Financial performance#
(Rs m) 3QFY11 4QFY11 Change FY10 FY11 Change
Sales 40,779 43,035 5.5% 125,650 158,554 26.2%
Expenditure 33,718 35,086 4.1% 99,922 131,364 31.5%
Operating profit (EBITDA) 7,061 7,949 12.6% 25,728 27,190 5.7%
Operating profit margin (%) 17.3% 18.5%   20.5% 17.1%  
Other income 125 71 -43.2% (532) 254  
Forex gain/(loss) (110) 83   (4,757) (799)  
Depreciation 1,181 1,290 9.2% 5,010 4,919 -1.8%
Profit before tax 5,895 6,813 15.6% 15,429 21,726 40.8%
Tax 1,281 1,701 32.8% 2,403 4,808 100.1%
Minority interest - 2   2 1  
Profit after tax/(loss) 4,613 5,109 10.7% 13,027 16,918 29.9%
Net profit margin (%) 11.3% 11.9%   10.4% 10.7%  
No. of shares (m)       679 689  
Diluted earnings per share (Rs)         24.6  
P/E ratio (x)*         19.9  
*On the basis of trailing 12 month; # Financial year ends June

What has driven performance in 4QFY11?
  • HCL Tech recorded a 5.5%% QoQ growth in sales during the quarter. This was largely driven by all round performance across all its business segments excluding BPO (5% of total sales). The infrastructure services business (25% of sales) grew by 10.8% QoQ while the core software services business (71%) clocked a 4.6% QoQ growth during the quarter. However, BPO segment recorded a decline of 4.2% QoQ during the quarter.
  • Segment-wise performance
    (Rs m) 3QFY11 4QFY11 Change
    Core Software 29,025 30,349 4.6%
    Infrastructure Services 9,531 10,557 10.8%
    BPO Services 2,223 2,130 -4.2%
    Revenue break-up by service offerings
    Enterprise application system 8,735 9,003 3.1%
    Engineering and R&D services 7,226 7,669 6.1%
    Custom Application (Industry Solutions) 13,057 13,694 4.9%
    Infrastructure Management 9,550 10,552 10.5%
    BPO 2,210 2,117 -4.2%
    Revenue break-up by geography
    US  22143 23411 5.7%
    Europe 11010 11662 5.9%
    Asia Pacific 7626 7961 4.4%
    Revenue by Industry vertical
    Financial services 10,684 11,189 4.7%
    Manufacturing 11,133 12,050 8.2%
    Telecom 4,200 3,916 -6.8%
    Retail & CPG 3,548 3,400 -4.2%
    Media Publishing and Entertainment 2,691 3,055 13.5%
    Healthcare 3,262 3,400 4.2%
    Energy-Utility & public sector 2,977 3,572 20.0%
    Others 2,284 2,453 7.4%

  • As regards industry verticals, HCL Tech recorded the best performance in 'Energy-Utility & public sector' vertical wherein sales grew by 20.0% QoQ during the quarter. This was followed by the 'Media Publishing and Entertainment' and 'Manufacturing' verticals which grew by 13.5% QoQ and 8.2% QoQ during the quarter. 'Financial Services' and 'Healthcare' verticals recorded growth of 4.7% QoQ and 4.2% QoQ respectively during the quarter. However, 'Telecom' and 'Retail & CPG' verticals witnessed a decline of 6.8% QoQ and 4.2% QoQ respectively during the quarter.

  • Based on service offerings, HCL registered a growth of 10.5% QoQ and 6.5% QoQ, respectively in its 'Infrastructure Management Services (IMS)' and 'Engineering and R&D services' segments. The 'Custom Application (Industry Solutions)' and 'Enterprise Application System (EAS)' business witnessed a growth of 4.9% QoQ and 3.1% QoQ respectively. However BPO services saw a decline of 4.2% QoQ as the company continues to restructure and reorganize the same.

  • HCL Tech witnessed positive traction across all its geographies. Revenues from US markets (54% of sales) saw an increase of 5.7% QoQ. Revenues from Europe (27% of sales) and Asia Pacific (19% of sales) grew by 5.9% QoQ ad 4.4% QoQ respectively during the quarter.

  • The company has signed 20 transformational deals during the quarter representing diverse industries including Manufacturing, Media and Publishing, Telecom, BFSI, Retail, Hi-Tech and Healthcare. Some of them are multi-year, multi-million dollar deals.

  • It added 70 new clients during the quarter. The total number of active clients at the end of June 2011 stood at 467.

  • Operating margins were up by 1.2% QoQ during the quarter. This was on account of lower operating expenses (as % of net sales) during the quarter.

  • HCL Tech's net profits improved by 10.7% QoQ during the quarter. This was on account of higher operating margins during the quarter, which offset the impact of higher tax rates. Tax rates have gone up from 21.7% in the previous quarter (3QFY11) to 25.0% during 4QFY11.

What to expect?
At the current price of 489, the stock is trading at a multiple of 14.6 times our estimated FY13 earnings.

HCL Tech witnessed a good quarter where growth was largely driven by volumes. The management has stated that the macro-economic indicators for the software industry do appear to be murky. However, despite this the management expects the deal pipeline to continue growing at a healthy pace in the coming quarters particularly in the October to December quarter of the current year. This would be driven by the churning among software vendors. And the company is confident that it would be benefit from this.

Going forward, the management expects pricing to remain stable. This is due to concerns over the overall macroeconomic environment as well as intense competition in the sector as a result of which it is not expected to go up in this year at least. The management stated that price uptick would come only when some value-added services would be offered.

The management stated that there would be pressure on the margins in the coming quarter due to the salary hikes that was given in the month of July, 2011. As a result, the impact on the margins would be to the tune of 3%. This also includes the impact of new employees that have joined the company which in turn would lead to higher staff costs However, for the financial year 2011-12, the management expects margins to remain at the same levels as those of financial year 2010-11. In the long term, the management expects optimization of 'Selling, General and Administration' expenses, better employee utilization, offshoring, employee mix, improvement in product mix and efficiency in delivery to drive the margins.

The tax rate is expected to be in the range of 24-25% for the financial year 2011-12.

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