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HCL Tech: Organic growth

Nov 1, 2003

HCL Tech (on a consolidated basis) announced its 1QFY04 results yesterday, reporting a sequential topline growth of 19%. Notably, this significant growth in the company's revenues has come about after a string of poor performances in the recent past. Increased taxation liability has, however, caused the company's bottomline to decline by a marginal 1% sequentially. Notably, HCL Tech managed to improve upon its operating margins for the quarter (rise of 70 basis points).

Financial performance: A snapshot
Rs m4QFY031QFY04Change
Sales4,710 5,608 19.1%
Other Income 589 494 -16.1%
Expenditure 3,923 4,630 18.0%
Operating Profit (EBDIT)787 978 24.3%
Operating Profit Margin (%)16.7%17.4% 
Interest - -  
Depreciation233 266 14.3%
Profit before Tax1,1421,2055.5%
Extraordinary items- -  
Stock-based sales incentive(11)(10) 
Tax90 160 78.6%
Minority interest & income of equity investee(84)(90) 
Profit after Tax/(Loss)958 946 -1.2%
Net profit margin (%)20.3%16.9% 
No. of Shares 285.4 285.4  
Diluted Earnings per share* (Rs)13.413.3 
P/E Ratio (x)  16.4  
(* annualised)   

HCL Tech's topline in 1QFY04 has been mainly propped by a 20.4% (3.4%) rise in the software services segment. However, this includes revenues of around Rs 309 m on account of the software services business acquired from HCL Infosystems, which was consolidated for the first time in 1QFY04. Excluding this, the sequential revenue growth for the software services business stands at around 12%. Out of this, the organic software business (around 75% of revenues) that had been under tremendous pressure till the last quarter (2% sequential decline in the last quarter) reversed its performance and grew 20% sequentially in 1QFY04. A shift towards offshore centric work and a marginal increase in onsite rates has helped the growth of HCL Tech's organic software business.

The company, going forward, seems to be anticipating increased demand for its software services and this can be seen in the huge recruitment that was effected in 2QFY04. HCL Technologies added a net of 1,478 employees to the software services segment, out of which around 1,040 were added to the inorganic segment alone. It is to be noted that, in the past, it is this (inorganic) segment that has acted as a bright spot in the poor performances that the HCL Tech has reported. The result of these employee additions is seen in the marginal decline (of 30 basis points) in the operating margins of the software services business (excluding BPO business). On client additions, HCL Tech added 36 new customers in 1QFY04, taking its clientele to 414 by the end of the quarter.

The company's BPO services (around 9% of revenues) witnessed a sequential revenue growth of 19% during the quarter. More importantly, operating margins for this segment, which fell to a negative 12% in the last quarter, improved to a marginal positive in 1QFY04. The net addition of employees to the BPO segment in the September quarter has been 394, with 260 and 134 additions for the organic and inorganic segments respectively.

At the current price of Rs 217, the stock is trading at a P/E multiple of 16.4x its annualised 1QFY04 earnings. While HCL Tech has reported substantially improved performance for this quarter, investors should not forget past performance of the company where the core business had been under tremendous pressure. While, as said earlier, HCL Tech's inorganic business has brought some respite to the company's overall performance, going forward, the growth would depend much on how its organic business performs. While pressure on billing rates seem to have stabilized for the company (in line with the sector), investors need to look beyond the quarterly numbers and wait for sustainability to come about in the overall performance.

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