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HCL Tech: Resilient performance maintained - Views on News from Equitymaster

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HCL Tech: Resilient performance maintained
Jul 31, 2013

HCL Technologies Ltd (HCL Tech) announced its fourth quarter and annual results (4QFY13) of financial year 2012-2013, (year ending June). The company reported an 8.1% quarter-on-quarter (QoQ) growth in sales and a 16.3% QoQ increase in net profits. Here is our analysis of the results.

Performance summary
  • Consolidated net sales grew by 8.1% QoQ in 4QFY13 (The company has a June year ending).
  • The growth in revenues was 3.9% QoQ on a constant currency basis. In terms of US dollar, revenues grew by 3.1% QoQ during the quarter.
  • EBITDA margin improved from 22.4% in 3QFY13 to 23.5% in 4QFY13. That was because the expenses grew at a slower pace as compared to the growth in sales.
  • Net profit grew at a much higher rate of 16.3% QoQ, because of a 32% QoQ rise in forex gains. While there was a fall in 'Other Income' (by 27.4% QoQ), muted growth in depreciation (by 2.7% QoQ) along with a fall in effective tax rate ensured the higher sequential growth rate of net profit.
  • Net employee count increased sequentially by 1,102 during the quarter. That was mainly due to a net increase of 686 in the head count of IT Services. Total employee base at the end of June 2013 was 85,505. Attrition in the IT services business increased from 14.2% in 3QFY13 to 14.9% in 4QFY13. However, attrition in the BPO services decreased from 7.9% in 3QFY13 to 6.9% in 4QFY13.
  • The company added 36 new clients during the quarter. The total number of active clients at the end of June 2013 increased to 549 from 547.
  • The company declared a final dividend of Rs 6 per share (dividend yield of 0.7%).

Consolidated Financial performance
(Rs m) 3QFY13 4QFY13 Change FY12 FY13 Change
Sales 64,246 69,442 8.1% 210,312 257,336 22.4%
Expenditure 49,854 53,154 6.6% 170,061 198,980 17.0%
Operating profit (EBITDA) 14,392 16,288 13.2% 40,251 58,356 45.0%
Operating profit margin (%) 22.4% 23.5% 1.1% 19.1% 22.7% 3.5%
Other income 657 477 -27.4% 706 1,769 150.6%
Forex gain/(loss) 231 305 32.0% (1,875) (198) 89.4%
Depreciation 1,634 1,678 2.7% 5,641 6,726 19.2%
Profit before tax 13,646 15,392 12.8% 33,441 53,201 59.1%
Tax 3,249 3,299 1.5% 8,180 12,217 49.4%
Minority interest (1) - -100.0% - -  
Profit after tax/(loss) 10,398 12,093 16.3% 25,261 40,984 62.2%
Net profit margin (%) 16.2% 17.4% 1.2% 12.0% 15.9%  
No. of shares (m)         696  
Diluted earnings per share(TTM) (Rs)         58.9  
P/E ratio (x)*         15.9  
*On the basis of trailing 12 month; # Financial year ends June
What has driven the performance in 4QFY13?
  • HCL Tech's sales growth of 8.1% QoQ was driven by a healthy growth of 13.8% QoQ in the infrastructure services business segment (31.5% of sales). The core Software business segment (64.2% of sales) registered a growth of 5.5% QoQ while for the BPO segment (4.3% of sales) revenues grew by 8.3% QoQ.

    Segment-wise performance
    (Rs m) 3QFY13 4QFY13 Change
    Core Software 42,263 44,569 5.5%
    Infrastructure Services 19,215 21,875 13.8%
    BPO Services 2,769 2,998 8.3%
    Revenue break-up by service offerings
    Enterprise application system 12,207 12,291 0.7%
    Engineering and R&D services 10,986 12,013 9.4%
    Custom Application (Industry Solutions) 19,081 20,277 6.3%
    Infrastructure Management 19,210 21,874 13.9%
    BPO 2,763 2,986 8.1%
    Revenue break-up by geography
    US  36,556 39,582 8.3%
    Europe 18,182 21,180 16.5%
    RoW 9,508 8,680 -8.7%
    Revenue by Industry vertical
    Financial services 16,062 17,569 9.4%
    Manufacturing 18,246 19,999 9.6%
    Telecom 4,561 5,069 11.1%
    Retail & CPG 5,718 5,972 4.4%
    Media Publishing and Entertainment 4,304 4,653 8.1%
    Healthcare 7,260 7,847 8.1%
    Energy-Utility & public sector 4,947 5,555 12.3%
    Others 3,084 2,778 -9.9%

  • With regard to industry verticals, HCL Tech recorded the best performance in the vertical of 'Energy, Utility and Public Sector', with a sales growth of 12.3% QoQ during the quarter. That was followed by the 'Telecom' segment, which saw a growth of 11.1% QoQ. 'Media, Publishing and Entertainment' and 'Healthcare' segments witnessed growth of 8.1% QoQ each. 'Manufacturing' and 'Financial Services' saw a growth of 9.6% QoQ and 9.4% QoQ respectively. 'Retail and CPG' saw a growth of 4.4% QoQ while 'Others' witnessed a de-growth of 9.9%.

  • Based on service offerings, HCL registered a growth of 13.9% QoQ in its 'Infrastructure Management Services (IMS)' while 'Enterprise Application System' grew by 0.7% QoQ. The 'BPO' segment grew by 8.1% QoQ. The 'Custom Application (Industry Solutions)' and 'Engineering and R&D' segments witnessed growth of 6.3% QoQ and 9.4% QoQ respectively during the quarter.

  • Revenues from Europe (30.5% of sales) witnessed the highest growth at 16.5% QoQ followed by US (57% of sales) at 8.3% QoQ. Revenues from 'Rest of the World' (12.5% of sales) saw a decline of 8.7% QoQ.

  • Compared to 3QFY13, client growth in US$ 10 million, US$20 millions, US$30 million, US$40 million and US$50 million was 4,0, 1,3, and 1 respectively. The Company added 36 new clients during the quarter. The total number of active clients at the end of June 2013 stood at 549.

  • As pointed out, EBITDA margin improved from 22.4% in 3QFY13 to 23.5% in 4QFY13 because the expenses grew at a slower pace compared to the growth in sales.

  • Net profit grew at a much higher rate of 16.3% QoQ, because of a 32% QoQ rise in forex gains. While there was a fall in 'Other Income' (by 27.4% QoQ), muted growth in depreciation (by 2.7% QoQ) along with a fall in effective tax rate from 23.8% at the end of 3QFY13 to 21.4% at the end of 4QFY13 ensured the higher sequential growth rate of net profit.

What to expect?

At the current price of Rs 937.8, HCL Tech's share is trading at a trailing twelve months(TTM) price-earnings (P/E) multiple of 15.9 times.

HCL Tech continued with its resilient performance for the seventh quarter in a row. Like the recent few quarters, revenue growth was primarily led by the growth of Infrastructure Management Services. In line with the past few quarters, strong order bookings to the tune of US$ 1 bn were witnessed during the current quarter as well. The deals booked are of long duration and more importantly across verticals.

Post the global financial crisis of 2008, HCL Tech was the first company to pre-empt that the spending pattern of clients was going to witness a massive change and accordingly it tried to create a niche by diverting its focus from core software to infrastructure management. The strategy has paid off handsomely as none of the larger Indian IT players have a marked presence in the infra segment and most IT clients are still concentrating on 'Run the Business' (RTB) projects rather than 'Change the Business' (CTB) projects. Further, we understand from the management that given the sensitive nature of 'infrastructure management', customers take decisions based on trust and are reluctant to switch vendors once the trust is developed. As a result further projects are awarded by the same client to their selected vendors. Most of these infra contracts fall under the category of 'managed services' providing dual advantages, i.e., non-linear growth and long –term annuity based revenue.

The management believes that for the next 4-5 years, companies will allocate more than 50% of their budgets on RTB, in which HCL Tech has developed an expertise, thus it is heartening to note that 'business is as usual' for HCL Tech with no signs of slowing down. Given their expertise as well as cost advantage, HCL Tech has been able to break through first generation outsourcing markets such as the Nordics and Germany in RTB/Infra.

THE BPO business has turned around and is complimenting the growth of Infra. However, software services have continued to disappoint and the growth has been just 5.3% YoY for the full year. While the EBIT margin for the quarter was 23.5%, management has continued to guide a margin in the range of 18-19%, given their intention of spending more on the sales force.

Given the slowdown in software services and focus on infra, HCL Tech has managed its workforce effectively. While attrition is slightly higher at a little over 14%, utilization (excluding trainees) has been very impressive at 84%. The Company gave no guidance with respect to new hires and we infer that they would continue to rely on the Just in Time (JIT) model for manpower, which is something that we like from a profitability perspective.

Through a change in strategy, HCL Tech is trying to narrow the gap between itself and the Top 3 peers, although a lot more needs to be done. The company's Return on Equity (RoE) has improved markedly from 22% in FY11 to 34% in FY13 and the effects of US$3.5 b deals won in the last three quarters will propel revenue growth going forward. The management has also stated that a host of re-bid deals would come up in 2HFY14. Therefore, further wins would bolster the top line over the coming years.

While we do acknowledge that the valuations may look attractive; however we believe that the company still needs to prove that the turnaround of fortunes and margin accretion is something that will stay in the long term. As such HCL Tech needs to continue delivering this superior performance for a while before it can command the valuations that its stronger peers get. Therefore current valuations, we believe factor in most of the upsides. We therefore reiterate our Sell view on the stock at current levels.

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