HCL Tech: Volatility persists - Views on News from Equitymaster

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks


Login Failure
(Please do not use this option on a public machine)
  Sign Up | Forgot Password?  

HCL Tech: Volatility persists

Oct 27, 2005

Introduction to results
HCL Technologies announced its results for the first quarter ending September 2005 (the company's financial year ends in June). For 1QFY06, revenues grew at a little under 5% sequentially, driven mainly by the software services business. BPO saw a second successive quarter of flat sequential growth and infrastructure management, which saw a double-digit growth in 4QFY05, has also been flat this quarter. Operating margins reduced due to expenses rising at a higher-than-proportionate rate than revenues, margin pressure in the software services and BPO segments. Due to a fall in other income and a higher effective tax rate, bottomline growth trailed topline growth.

Financial performance (US GAAP consolidated): A snapshot...
(Rs m) 4QFY05 1QFY06 Change
Sales 9,276 9,707 4.6%
Expenditure 7,164 7,549 5.4%
Operating profit (EBDIT) 2,111 2,158 2.2%
Operating profit margin (%) 22.8% 22.2%  
Other income 139 124 -10.6%
Depreciation 463 447 -3.5%
Profit before tax 1,787 1,835 2.7%
Tax 140 169 20.6%
Minority interest & income of equity investee (27) 9  
Extraordinary income - -  
Profit after tax/(loss) 1,620 1,675 3.4%
Net profit margin (%) 17.5% 17.3%  
No. of shares 319.2 320.0  
Diluted earnings per share* (Rs)   20.9  
P/E ratio (x)   21.1  
(* annualised)      

What is the company's business?
HCL Technologies is the fifth-largest software services exporter from the country and is focused on research and development (R&D) outsourcing. Its service offerings include technology-led services (24% of revenues), enterprise consulting services (18%), applications consulting services (34%), ITES (13%) and infrastructure services (10%). While the company has witnessed volatility in its core business, it has done well to grow its inorganic businesses. HCL Tech's focus on R&D outsourcing and its experience in technology development services gives it a competitive edge over its peers.

What has driven performance in 1QFY06?
Software services show the way: During the quarter, HCL Tech's software services division was the key growth driver. This segment grew revenues by 5.1% sequentially and accounted 91.3% of the total incremental revenues of the company in 1QFY06. The management has indicated that software services will continue to be the main focus area and that BPO and infrastructure management helps the company to build a 'go-to-market' strategy. It should be mentioned here that software services contribute to 76.6% of HCL's revenues and thus, if this segment does not grow, overall revenues will also suffer. This growth is decent and comes off a near-9% QoQ growth in 4QFY05. If HCL Tech is able to continue maintaining this performance, then revenue growth could be more stable, going forward.

As regards BPO, this segment saw a second successive quarter of flat growth, increasing revenues by just 1.2% QoQ. In the conference call, the management has stated that this business is a typically characterised by longer-term-large-volume contracts and thus, is prone to quarterly aberrations. This segment has grown at a significant pace in the recent past and is the third-largest BPO services provider in the country.

On the other hand, the infrastructure management segment has also witnessed flat growth of 1.9% QoQ. This comes off a 14.9% growth in 4QFY05. The YoY picture is encouraging, as BPO grew by 44% while infrastructure management has grown by around 67% YoY.

Gross revenues by segment: IT services lead the way
4QFY05 % of revenue 1QFY06 % of revenue Change
Software 7,072 75.9% 7,434 76.6% 5.1%
BPO 1,291 13.9% 1,307 13.5% 1.2%
Infrastructure 951 10.2% 969 10.0% 1.9%
Total 9,314 100.0% 9,710 100.0% 4.3%

HCL Tech added a net of 2,195 employees in 1QFY06, the highest-ever addition in a quarter. The total manpower strength of the company now stands at 26,185. This strong addition of manpower implies that the company has a good pipeline of orders in place. It should be noted that HCL Tech has consciously followed a strategy to win larger, multi-year and multi-service orders and work with a fewer number of clients.

Margins fall: During 1QFY06, margins in both the software services segment as well as BPO segment reduced by 30 basis points and 240 basis points respectively, which has been the major reason for the fall in margins. This was tempered to an extent by a 140 basis point margin expansion in the infrastructure management segment. In fact, despite the big margin contraction in BPO, margins in this segment are still 350 basis points higher than in software services.

Lower other income, higher taxes restrict net profit: HCL Tech's net profit grew at a fairly slow pace of 3.4% sequentially. The company recorded a forex loss in the quarter. It has US$ 350 m in forward contracts at an average price of Rs 42.44 to a dollar and as a result, ahs been unable to participate in the rally of the dollar of late. Therefore, HCL Tech recorded a loss of Rs 30 m on this front, as compared to Rs 52 m profit in 4QFY05. The effective tax rate was also higher, leading to the subdued profit growth of 3.4% QoQ.

Performance in the recent past...
2QFY05 3QFY05 4QFY05 1QFY06
Sales (QoQ growth, %) 2.5 7.1 8.1 4.6
Operating margins (%) 23.0 22.8 22.8 22.2
Profits (QoQ growth, %) (20.1) 21.7 3.0 3.4
Employees (Nos.) 20,249 22,034 24,090 26,285

What to expect?
At the current price of Rs 431, the stock is trading at a price to earnings multiple of 21.1 times its annualised 1QFY06 earnings. The company board has recommended an interim dividend of 200% (Rs 4 per share, dividend yield of 0.9%). The company's inconsistent performance has continued this quarter and it has under-performed the 'Top 4' software companies that have so far declared their results. However, the strong hiring this quarter does suggest that the company has a good order pipeline in hand.

It should be noted that HCL Tech is now consciously following a strategy of going only for large-sized deals. In line with this, it managed to win 2 deals of over US$ 50 m and one deal of US$ 100 m in the quarter. However, this strategy would, thus, imply that volatility in its performance would continue in the foreseeable future. The software services division is expected to continue to exhibit volatility until it gains a sizeable scale. BPO, infrastructure management and ERP are expected to continue to be the major growth drivers for the company, going forward. HCL Tech has also re-aligned its service lines into five main services - technology-led services, enterprise consulting services, applications consulting services, ITES and infrastructure services. This will enable the company to focus more on these service lines and thus, gives it a go-to-market strategy. However, we continue to prefer other companies, like Infosys and Satyam over HCL Tech, going forward.

To Read the Full Story, Subscribe or Sign In
To Read the Full Story, Subscribe or Sign In

Become A Smarter Investor
In Just 5 Minutes

Multibagger Stock Guide 2022
Get our special report Multibagger Stocks Guide (2022 Edition) Now!
We will never sell or rent your email id.
Please read our Terms


Dec 3, 2021 (Close)


  • Track your investment in HCL TECHNOLOGIES with Equitymaster's Portfolio Tracker. Set live price alerts, get research alerts and more. Get access now...
  • Add To MyStocks