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HCL Tech: Wage hikes hurt margins
Oct 20, 2010

HCL Tech has announced its 1QFY11 results. Sales increased by 5% QoQ while net income declined by 6% QoQ during the quarter. Here is our analysis of the results.

Performance summary
  • Net sales grew by 5% QoQ during the quarter. Growth was largely driven by all segments and verticals.
  • Operating margins declined marginally by 2.4% QoQ. This was largely due to increase in wages during the quarter.
  • Net profits declined marginally by 6% QoQ. Profits were impacted by extraordinary losses on cash flow hedges and forex transactions as well as by higher tax rates.
  • Added 18 new clients during the quarter. The total number of active clients as at end of September 2010 stood at 426.
  • Added 5,661 (net) employees during the quarter. Total employee base at the end of September 2010 was 70,218. Attrition rate rose to 16.7%.
  • Declared an interim dividend of Rs 1.50 per share.


(Rs m) 4QFY10 1QFY11 Change
Sales 34,254 36,116 5.4%
Expenditure 27,873 30,240 8.5%
Operating profit (EBITDA) 6,381 5,876 -7.9%
Operating profit margin (%) 18.6% 16.3% -2.4%
Other income (209) 4  
Forex gain/(loss) (1,370) (638)  
Depreciation 1,131 1,217 7.6%
Profit before tax 3,671 4,025 9.6%
Tax 254 802 215.7%
Minority interest & income of equity investee                   1 2  
Profit after tax/(loss) 3,418 3,225 -5.6%
Net profit margin (%) 10.0% 8.9%  
No. of shares (m)          689.5        680.0  
Diluted earnings per share (Rs)             19.2  
P/E ratio (x)*             22.6  

What has driven performance in 1QFY11?
  • HCL Tech recorded a 5.4%% QoQ growth in sales during the quarter. This was largely driven by all round performance across all its business segments including BPO (6% of total sales). As per the management, this growth was largely fuelled by the growth in volumes witnessed during the quarter. The infrastructure services business (22% of sales) grew by 5% QoQ while the core software services business (72%) grew by 6% QoQ.

    Segment-wise performance
    (Rs m) 4QFY10 1QFY11 Change
    Core Software 24,463 25,868 5.7%
    Infrastructure Services 7,678 8,087 5.3%
    BPO Services 2,113 2,161 2.3%
    Revenue break-up by service offerings      
    Enterprise application system 7,604 7,837 3.1%
    Engineering and R&D services 6,714 6,754 0.6%
    Custom Application (Industry Solutions) 10,139 11,304 11.5%
    Infrastructure Management 7,673 8,054 5.0%
    BPO 2,124 2,167 2.0%
    Revenue break-up by geography      
    US 21066 20947 -0.6%
    Europe 8426 9643 14.4%
    Asia Pacific 4761 5526 16.1%
    Revenue by Industry vertical      
    Financial services 8,529 9,101 6.7%
    Manufacturing 9,351 9,824 5.0%
    Telecom 3,734 3,973 6.4%
    Retail & CPG 2,809 3,070 9.3%
    Media Publishing and Entertainment 2,535 2,492 -1.7%
    Life Sciences 2,809 3,034 8.0%
    Energy-Utility &public sector 2,364 2,456 3.9%
    Others 2,124 2,167 2.0%

  • As regards industry verticals, HCL Tech recorded the best performance in ‘retail & CPG’ vertical where sales grew by 9% QoQ during the quarter. This was followed by the ‘life sciences vertical which grew by 8% QoQ. ‘Financial services, ‘telecom’ and ‘manufacturing’ verticals recorded growth of 7%, 6% and 5% QoQ respectively during the quarter. The ‘media publishing and entertainment’ vertical witnessed a decline of 2% QoQ during the quarter.

  • Based on service offerings, HCL registered a strong growth of 12% QoQ in its custom application segment. The Infrastructure Management Services (IMS) business and the Enterprise Application System (EAS) business witnessed a growth of 5% QoQ and 3% QoQ respectively during the quarter. Sales from the BPO grew by 2%. As per the management, the restructuring of the BPO business is almost complete and this segment should witness a healthy traction going forward. The Engineering and R&D services segments saw a muted growth of 0.6% QoQ.

  • HCL Tech recorded traction from Europe as well as from the Asia Pacific regions during the quarter. Business from Europe and Asia Pacific regions grew by 14% QoQ and 16% QoQ respectively. However, sales from the US, its major market, declined by 0.6% QoQ during the quarter. The company has won several deals during the quarter and has a robust order pipeline which will aid growth going forward.

  • HCL Tech added 18 new clients during the quarter where some of the new wins are multi-year, multi-million dollar deals. The total number of active client at the end of September 2010 stood at 426.

  • Operating margins contracted 2.4% QoQ during the quarter. This was largely on account of the wage hike during the quarter. While selling and administrative expenses are expected to remain high, the management is confident that overall margins for the year will remain at healthy levels.

  • HCL Tech’s net profits declined by 6% QoQ during the quarter. Profits were impacted by extraordinary losses on cash flow hedges and forex transactions as well as by higher tax rates.

What to expect?
At the current price of 434, the stock is trading at a multiple of 16.8 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. In fact the current quarter has witnessed one of the highest order inflows for the company. The new deals are flowing in from clients seeking to reduce costs as well as from clients seeking new transformational deals. The new deals are also from the churn from smaller IT vendors to larger players as the industry is witnessing vendor consolidation.

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 also investing heavily into the selling, general and administration (SG&A) side. This is expected to remain high (as percentage of total sales) in the next quarter as well. The management is confident that the benefits of these would flow in the future. The management has set up an enterprise business incubation unit which would be something like a think tank that will throw up new business opportunities to be encashed in the future. The company has spent US$ 50 m as an investment to set this unit up. This amount is accounted for in SG&A. Despite the increased SG&A, the management is confident of maintaining full year margins at levels seen last year.

Going forward, the management expects margins to be sustained at current levels as continued investments into the business will offset the growth in revenues.

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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