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HCL Tech: Core services drive growth
Jul 29, 2010

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

Performance summary
  • Net sales grew by 19% YoY during FY10 (financial year ended June 2010) and 11% QoQ during 4QFY10. Growth was largely driven by all segments, geographies, and verticals.
  • Operating margins declined marginally by 1.3% YoY during the year and 1.1% QoQ during the quarter. This was largely due to lower profits from the BPO segment.
  • Net profits declined marginally by 0.6% QoQ during 4QFY10 but grew by 2% YoY for FY10.
  • Profits for the quarter were impacted by extraordinary losses on cash flow hedges and forex transactions.
  • Added 4 new clients during the quarter - total number of active clients as at end of June 2010 stood at 408.
  • Added a record 6,428 employees during the quarter - total employee base at the end of June 2010 was 64,557. Attrition rate rose to 15.7%.
  • Proposed a dividend of Re 1 per share. Total dividend for the year is Rs 4 per share.


Financial performance#
(Rs m) 3QFY10 4QFY10 Change FY09 FY10 Change
Sales 30,757 34,254 11.4% 105,910 125,650 18.6%
Expenditure 24,684 27,873 12.9% 82,845 99,921 20.6%
Operating profit (EBITDA) 6,073 6,381 5.1% 23,065 25,729 11.5%
Operating profit margin (%) 19.7% 18.6%   21.8% 20.5%  
Other income (141) (209) 48.2% 1,651 (532)  
Forex gain/(loss) (626) (1,370) 118.8% (4,908) (4,757) -3.1%
Depreciation 1,099 1,131 2.9% 4,492 5,010 11.5%
Profit before tax 4,207 3,671 -12.7% 15,316 15,430 0.7%
Tax 769 254 -67.0% 2,544 2,401 -5.6%
Minority interest & income of equity investee 1 1 0.0% 5 2  
Profit after tax/(loss) 3,439 3,418 -0.6% 12,777 13,027 2.0%
Net profit margin (%) 11.2% 10.0%   12.1% 10.4%  
No. of shares (m)       674.0 689.5  
Diluted earnings per share (Rs)         18.9  
P/E ratio (x)*         20.7  
*On the basis of trailing 12 month; # Financial year ends June

What has driven performance in FY10?
  • HCL Tech recorded a 19%% YoY growth in sales during FY10. This was largely driven by all round performance across all its business segments except BPO (8% of total sales) where sales declined by 1around 13% YoY. The infrastructure services business (21% of sales) grew by a whopping 54% YoY during the year. The core software services business (71%) grew by 15% YoY.

    Segment-wise performance
    (Rs m) 3QFY10 4QFY10 Change
    Core Software 21,608 24,463 13.2%
    Infrastructure Services 6,816 7,678 12.6%
    BPO Services 2,333 2,113 -9.4%
    Revenue break-up by service offerings      
    Enterprise application system 6,582 7,604 15.5%
    Engineering and R&D services 5,844 6,714 14.9%
    Custom Application (Industry Solutions) 9,196 10,139 10.3%
    Infrastructure Management 6,828 7,673 12.4%
    BPO 2,338 2,124 -9.1%
    Revenue break-up by geography      
    US 18300 21066 15.1%
    Europe 8212 8426 2.6%
    Asia Pacific 4244 4761 12.2%
    Revenue by Industry vertical      
    Financial services 7,843 8,529 8.7%
    Manufacturing 8,212 9,351 13.9%
    Telecom 3,568 3,734 4.6%
    Retail & CPG 2,307 2,809 21.8%
    Media Publishing and Entertainment 2,430 2,535 4.3%
    Life Sciences 2,307 2,809 21.8%
    Energy-Utility & public sector 2,153 2,364 9.8%
    Others 1,938 2,124 9.6%

  • As regards industry verticals, HCL Tech recorded the best performance in 'media publishing & entertainment’ where sales grew by 55% YoY during the year. This was followed by the 'retail & CPG' vertical which grew by 38% YoY. 'Life sciences', 'financial services' and 'telecom' verticals recorded robust growth of 36%, 23% YoY and 14% YoY respectively during the quarter.

  • Based on service offerings, HCL registered a strong growth of 43% YoY in its Enterprise Application System (EAS) business wherein the company implements critical enterprise software solutions for various businesses. Growth of around 54% was witnessed in the Infrastructure Management Services (IMS) business. Healthy traction was also seen in the custom application domain. Sales from the BPO and engineering and R&D services segments declined by 13% YoY and 3% YoY respectively.

  • HCL Tech recorded remarkable traction from all the geographies during FY10. Sales from the US, its major market, grew by around 19% YoY, contributing around 60% to total sales during the year. Business from Europe and Asia Pacific regions grew by 16%YoY and 24% YoY respectively. The company has won several deals in Europe and expects growth in this segment to be robust going forward.

  • HCL Tech added 41 new clients during the year where some of the new wins are multi-year, multi-million dollar deals. The total number of active client at the end of June 2010 stood at 408.

  • Operating margins contracted marginally by 1.3% YoY during the year and 1.1% QoQ during the quarter. This was largely due to lower profits from the BPO segment.

  • HCL Tech’s net profits declined marginally by 0.6% QoQ during 4QFY10 but grew by 2% YoY for the full year. Profits for the quarter were impacted by extraordinary losses on cash flow hedges and forex transactions.

What to expect?
At the current price of 383, the stock is trading at a multiple of 15.1 times our estimated FY12 earnings (ResearchPro subscribers, kindly click here). During the conference call, HCL Tech’s management appeared optimistic for the future. It stated that the company is seeing a strong deal pipeline. However this is not so much from new customers but more as an expansion of business from the existing customers. The new deals are also from the churn from smaller IT vendors to larger players as the industry is witnessing vendor consolidation. The management stated that as of now they do not see an increase in discretionary spend from the customers. This is quite a deviation from what the three IT majors – Infosys, TCS and Wipro – reported earlier.

HCL Tech is investing heavily into each of its business segments as the company feels these investments will help it cope with the competition that is expected to come in the future. It is revamping its BPO segment due to which it has been showing losses in the current quarter. This trend is expected to continue for at least the next 6 quarters. However, for FY12-13, the management is optimistic that the BPO segment will exhibit a healthy growth and profits.

Going forward, the management expects margins to be sustained at current levels as continued investments into the business will offset the growth in revenues. They did add a word of caution that margins will take a hit during the next quarter due to the proposed salary hike.

Despite the global downturn that plagued the entire IT sector all through the year, HCL Tech has posted better than expected financial performance during FY10. Despite the stellar performance, the company continues to trade at lower valuations as compared to its peers. The most important reason for these lower valuations is the concern regarding the company's management that has made some shareholder unfriendly acquisitions in the past. As such, despite the stock's low valuations, we have a cautious view on the same.

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