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HCL Technologies: A lot to come? - Views on News from Equitymaster
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  • Sep 11, 2002

    HCL Technologies: A lot to come?

    HCL Tech pleased the markets with its performance for 4QFY02. The software major recorded a 6% sequential growth in revenues. However, the net profit figured almost halved as compared to 3QFY02. This is due to a write off amounting to Rs 367 m and a decline in operating margins. While the company finally saw volumes growing in 4QFY02, falling realisations to eroded margins.

    Most of the growth came from that company’s core software business for which HCL Technologies (standalone) is responsible. The growth came after three consecutive quarters of sequential decline in revenues, which was due to the tough business environment. While at one end the billing rates were heading south due to increased competition, HCL Technologies under performed, as it could not manage volume growth either. Other software majors, offset the decline in billing rates that was an industry wide phenomena by ramping up volumes. Finally in 4QFY02, HCL Technologies saw a strong growth in volumes.

    Volume growth 2QFY02 3QFY02 4QFY02
    Offshore 1.2% 2.5% 6.2%
    Onsite -5.9% -11.4% 7.0%
    Total -0.4% -0.4% 6.3%

    The company’s topline growth for FY02 was much lower than the industry average of 22%. The reason for the poor performance was due to the most dominant revenue stream, technology development services (TDS), faring badly. The TDS group provides IT services to the hi-tech industry especially the telecom and other IT companies. The spending for projects undertaken by the group comes mostly from R&D budgets of clients. However, the hi-tech industry has been the worst hit by the economic slowdown and has cut down on its spending. Consequently, the contribution from TDS to total revenues declined from 49% in 1QFY02 to 37% in 4QFY02.

    Revenue break-up 1QFY02 2QFY02 3QFY02 4QFY02
    TDS 49.4% 44.0% 37.3% 37.0%
    Networking 12.7% 13.4% 15.7% 12.0%
    Software product engineering 12.7% 14.4% 15.1% 18.0%
    Applications 25.3% 26.9% 27.9% 28.0%
    ITES - 1.3% 4.0% 5.0%
    Total 100.0% 100.0% 100.0% 100.0%

    While the company managed to address concerns regarding growth its operating margins continue to be a cause for concern. While decline in billing rates are largely responsible for the erosion in margins, the company’s aggressive growth policy too has taken a toll on the operating margins. HCL Technologies made a number of acquisitions ventures during the fiscal. These include Deutsche Software, HCL Technologies NI (Apollo Contact Centre) and Gulf Computers. Also, the company entered into a joint venture with the Jones Apparel Group, US. Since these businesses are mostly in the nascent stages the operating margins are much lower as compared to software businesses’ margins. Consequently, the consolidated numbers look depressed.

    Operating margins
    Organic 2QFY02 3QFY02 4QFY02
    HCL Technologies 29.4% 30.8% 28.6%
    HCL Comnet 15.5% 8.6% 9.8%
    E-Serve -266.7% -115.4% -88.2%
    Total organic 27.1% 26.7% 25.6%
    Deutsche Software 28.4% 27.4% 29.7%
    HCL Enterprise solutions 17.2% 13.7% 7.6%
    HCL Technologies NI 10.9% 7.3% 5.1%
    Gulf - - 20.3%
    HCL Jones - - 15.1%
    Total inorganic 22.5% 18.2% 17.5%
    Total consolidated 26.5% 25.5% 24.3%

    While the acquisitions are depressing numbers for the short term, the strong growth in business segments like ITES could significantly improve HCL Technologies financials in the future. For example, the company’s ITES subsidiary HCL Tech NI has already posted a net profit (excluding minority interest) of Rs 23 m for 4QFY02. But it will quite sometime before, the ITES business has a major impact on the company’s financials. Also, HCL Technologies is steadily diversifying its revenues streams. The contribution from software and related business to total revenues have decline swiftly from 87% in 1QFY02 to 80% in 4QFY02. Further, the growth potential for its revenue streams in significant. This will help the company to dilute risks due to concentration on a particular revenue stream.

    Revenues as a % of consolidated revenues
    Organic 2QFY02 3QFY02 4QFY02 Change*
    HCL Technologies 76.6% 72.1% 72.2% 5.7%
    HCL Comnet 11.9% 14.2% 11.4% -16.2%
    E-Serve 0.1% 0.3% 0.3% 80.0%
    Total organic 88.6% 86.6% 83.9% 2.3%
    Deutsche Software 6.1% 6.2% 6.8% 16.6%
    HCL Enterprise solutions 4.2% 3.6% 3.6% 10.4%
    HCL Technologies NI 1.1% 3.7% 4.1% 17.1%
    Gulf - - 1.3% -
    HCL Jones - - 0.2% -
    Total inorganic 11.4% 13.4% 16.1% 26.8%
    Total consolidated 100.0% 100.0% 100.0% 5.7%

    *Sequential growth for 4QFY02

    At the current market price of Rs 220, the stock is trading at a P/E multiple of 13x its FY02 annualised earnings. While the short-term picture for the software industry is hazy, considering a three to five year perspective the company seems to be attractively priced. However, further acquisitions and the joint ventures by the company could take a toll on the financials. This could cause volatility in the stock price.



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