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Hughes Software: Product business ails...again! - Views on News from Equitymaster
 
 
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  • Oct 14, 2004

    Hughes Software: Product business ails...again!

    Introduction to results
    Hughes Software Solutions (HSS), on a standalone basis, has reported decent growth for the quarter and half year ending September 2004. Initiatives on the expenditure front have helped the company in improving margins for both the periods.

    Financial performance (Standalone): A snapshot
    (Rs m) 1QFY05 2QFY05 Change 1HFY04 1HFY05 Change
    Sales 1,083 1,166 7.7% 1,615 2,249 39.3%
    Other income 32 15 -53.1% 35 47 34.3%
    Expenditure 785 833 6.1% 1,178 1,617 37.3%
    Operating profit (EBDIT) 298 333 11.7% 437 632 44.6%
    Operating profit margin (%) 27.5% 28.6%   27.1% 28.1%  
    Depreciation 57 62 8.8% 106 119 12.3%
    Profit before tax 273 286 4.8% 366 560 53.0%
    Tax 26 28 7.7% 43 54 25.6%
    Profit after tax/(loss) 247 258 4.5% 323 506 56.7%
    Net profit margin (%) 22.8% 22.1%   20.0% 22.5%  
    No. of shares 33.7 34.0   33.7 34.0  
    Diluted earnings per share* (Rs) 29.1 30.4   19.0 29.8  
    P/E ratio (x)   18.8     19.2  
    * annualised            

    Leading telecom solutions provider
    HSS, a subsidiary of the Singapore-based electronic manufacturing services provider, Flextronics, is a focused player in networking and communications related systems software. As the downturn engulfing the telecom industry worldwide forced the company to broaden its service portfolio, it is now eyeing larger share of revenues from the telecom service providers, business process outsourcing and the financial services industry for future growth. The largest contributor to HSS’ revenues is the services segment (82% contribution), followed by products (14%) and BPO (4%).

    What has driven performance?

  • Non-HNS services aid growth momentum: Non-HNS revenues (65% contribution) continue to drive HSS’ topline growth as seen in this quarter as well. While revenues from HNS (the erstwhile parent) grew QoQ by a meager 2%, growth in non-HNS revenues was over 11% sequentially. Growth in the product business (0.5% QoQ) remained sluggish and this is a cause for concern. In a recent meeting with us, the management indicated that it is expecting strong demand from the Voice over Internet Protocol (VoIP) technology space and this is the area where the company is likely to have most of its product and service offerings. While the effect is already being seen in the non-HNS services space, the product business is still to attain momentum. BPO business (4% of revenues) grew sequentially by 8% in 2QFY05. Also, while revenues from Tenet Technologies (HSS’ subsidiary) are not included in the standalone numbers, the same grew sequentially by 9%. HSS added 14 new clients in the quarter.

  • Topline growth and lower staff costs help margins: Apart from the growth in topline, reduced staff costs also helped margin improvement in 2QFY05. As a matter of fact, staff costs (as percentage of sales) declined from 49% in 1QFY05 to 47% in 2QFY05. This was despite a gross addition of 439 employees in the quarter. Margins were also strengthened by a strong utilisation in the quarter (92%). Improvement in margins was, however, pared by a rise in travel costs that increased to 8% from 6% in 1QFY05. Going forward, any further improvement in HSS margins is likely to be led by growth in its product business, revenues from which generally flow to the bottomline without adding much to expenses.

  • Other income mar profits: Despite improvement in operating margins in 2QFY05, the net profit margins witnessed a decline of 70 basis points. This seems mainly a result of a large decline in other income. While the company has not mentioned any specific reason for this decline, it seems a result of forex losses on account of depreciation in the value of rupee vis-à-vis the US dollar.

    Over the last few quarters
    While HSS has managed to witness a slow yet steady growth in revenues, profitability growth has been very volatile. The company has consistently failed in improving performance from the products division and has reported sedate growth in the otherwise fast growing segment of BPO services. This seems to have had a negative affect on the overall performance of the company during the last one year.

    Performance in recent times
      3QFY04 4QFY04 1QFY05 2QFY05
    Sales growth (%, QoQ) 13.5 3.9 8.0 7.7
    OPM (%) 31.2 26.2 27.5 28.6
    Profits (%, QoQ) 41.4 (11.3) 27.8 4.5
    Services (QoQ growth, %) 19.5 2.6 10.7 9.0
    Products (QoQ growth, %) (4.4) 10.4 (4.7) 0.5
    BPO (QoQ growth, %) (9.2) 3.9 8.0 7.7

    What to expect?
    At the current price of Rs 572, the stock is trading at a P/E multiple of 19.2 times (standalone) and 19.4 times (consolidated) annualised 1HFY05 earnings, which are on the higher side of the valuation spectrum. For the consolidated entity (including Tenet), the management has projected sales and profits to grow sequentially by 5%-6% each in 3QFY05. This seems in line with the management’s earlier estimates of 30%-35% and 33%-37% YoY growth in sales and profits respectively for FY05. While we believe that the company will be able to achieve these growth levels with much help from the new parent, Flextronics, our big concern pertains to the retarded growth of the high margin products business.

    Concerns also arise on account of the fact that Flextronics might de-list HSS from the Indian bourses, as has been seen in past cases of other MNCs doing the same with their listed Indian subsidiaries (remember HP and Digital?).

     

     

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