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HCL Infosys: On a higher wavelength!

Oct 21, 2004

Introduction to results
HCL Infosystems has announced its consolidated results for the first quarter of FY05, reporting strong YoY growth in both the topline and the bottomline. Strong growth across all segments has helped rev up the company’s performance in 1QFY05. However, rising raw material costs, intensifying competition and the consequent pricing pressure seems to have taken toll on its margins. On a standalone, while revenues have grown YoY by 24%, profits are almost flat.

Financial performance (Consolidated): A snapshot…
(Rs m) 1QFY04 1QFY05 Change
Sales 8,290 15,653 88.8%
Expenditure 7,922 15,148 91.2%
Operating profit (EBDIT) 368 505 37.2%
Operating profit margin (%) 4.4% 3.2%  
Other income 78 85 9.0%
Interest 11 2 -81.8%
Depreciation 40 35 -12.5%
Profit before tax 395 553 40.0%
Tax 71 122 71.8%
Extraordinary items      
Profit after tax/(loss) 324 431 33.0%
Net profit margin (%) 3.9% 2.8%  
No. of shares 32.6 33.0  
Diluted earnings per share* (Rs) 39.3 52.2  
P/E ratio (x)   12.3  
(* annualised)      

India’s largest PC maker
HCL Infosystems, India’s largest personal computer (PC) maker, is primarily engaged in the information technology related hardware business. Its other interests (apart from PCs) in hardware include trading and assembling of equipments like printers, scanners, photocopiers, cellular phones and EPABX systems. The very low levels of PC penetration in the country (around 5 per 1,000 population) present the biggest opportunity for higher growth for HCL Infosys going forward. Its number one position is, however, under serious threat due to low barriers to entry in this business.

What has driven performance in 1QFY05?
All-round growth perks topline: Growth in revenues from the office automation & telecommunication (OAT) business (75% of 1QFY05 consolidated revenues) continues to be the growth driver for HCL Infosystems. In this quarter, revenues from this segment grew YoY by 127%, and this seems mainly a result of robust growth in the company’s cellular handset (Nokia) distribution business. The rapid expansion by major cellular players across the length and breadth of the country has helped HCL Infosystems add new customers to its fold, thus leading to a strong growth of this business. Reducing prices of handsets has also aided this fast growth in the OAT segment.

Revenues from the second largest business stream of the company, computer systems & other related products, also clocked in a strong YoY growth of 24%. This segment now contributes to 24% of the company’s revenues and has benefited from large orders from some PSU banks and major technology companies. Apart from a slew of new products launches in the quarter, HCL Infosystems launched a PC financing facility, wherein a PC can be bought for as low as Rs 499 per month. In a low PC penetration country, where affordability is a key factor in PC purchases, these measures are likely to stand in good stead for the company in its future growth. The third segment, Internet and related services (1% of revenues), grew YoY by 20%.

High input costs dent margins: Despite a fall in excise duty (as percentage of sales) from 3.2% in 1QFY04 to 0.9% in 1QFY05, a strong rise in cost of sales have dented the company’s margins in this quarter. These costs have increased to 94% of sales in 1QFY05, from 78% in the corresponding quarter last fiscal. Also, while the press release does not explicitly state this fact, we believe that the company has faced pressure on realisations, as competition (both from unorganised and MNC players) seems to be intensifying in this sector. Lower duties for both computers and mobile handsets, and the need to pass these on to consumers, might also have reduced realisations for the company in 1QFY05.

Lower operating margins affects net profits: Factors like decline in operating margins and higher tax outgo have affected the net profit growth in the quarter. Net profit growth has trailed growth in topline in the past few quarters as well, and this is indicative of the competitive pressures on the company.

What to expect?
At the current price of Rs 644, the stock is trading at a P/E multiple of 12.3 times annualised 1QFY05 earnings. The board of the company has recommended a quarterly interim dividend of Rs 7 per share (70%).

With its direct customer service contacts at 260-plus locations around the country, HCL Infosystems has managed to outperform the industry growth and emerge market leader in the desktop PC segment (13.3% share). The company has also benefited from a rapid growth in demand for GSM handsets. We believe that, going forward, as income levels rise and consequently the demand for desktop PCs and cellular handsets, strong growth is likely to continue for the company. Potentially larger investments in hardware from Indian corporates also promise strong times ahead.

However, much will depend on how the company is able to modify its product offerings in times of rapidly changing technology and ward-off intensifying competition from the unorganised sector (private PC assemblers) and MNCs like IBM, Dell and HP. Considering these factors, and that valuations are at the higher end of the spectrum, we would advice investors to practice caution.

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