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HCL Tech: Operating costs spoils performance
Nov 4, 2014

HCL Technologies (HCL Tech) announced its first quarter (1QFY15) of financial year 2014-2015 (the company has a June year ending). The company reported a 3.7% QoQ growth in sales and a 2.1% QoQ increase in net profits. Here is our analysis of the results.

Performance summary
  • Consolidated sales grew by 3.7% QoQ in 1QFY15 (The company has a June year ending). In constant currency terms sales were up 3.2% QoQ.
  • Operating profits decreased by 1.1% QoQ in while the operating margin fell to 25.1% in 1QFY15 as compared to 26.3% 4QFY14. This was due to a 5.9% QoQ increase in direct costs.
  • The consolidated net profit grew by a muted pace of 2.1% QoQ.
  • The company has declared an interim dividend of Rs 6 per share.

Consolidated Financial performance
(Rs m) 4QFY14 1QFY15 Change
Sales 84,240 87,350 3.7%
Expenditure 62,070 65,430 5.4%
Operating profit (EBITDA) 22,170 21,920 -1.1%
Operating profit margin (%) 26.3% 25.1%  
Other income (net of finance costs) 2,110 3,580 69.7%
Forex gain/(loss) (530) (530)  
Depreciation 1,770 1,040 -41.2%
Profit before tax 21,980 23,930 8.9%
Tax 3,620 5,190 43.4%
Minority interest 1 1  
Profit after tax/(loss) 18,360 18,740 2.1%
Net profit margin (%) 21.8% 21.5%  
No. of shares (m)   701.3  
Diluted earnings per share (TTM)   99.4  
P/E ratio (x)*   15.8  
*On the basis of trailing 12 month; # Financial year ends June

What has driven performance in 1QFY15?
  • In terms of the performance metrics, HCL Tech delivered a mixed in the quarter. Growth was led by the enterprise services, engineering services, the retail vertical and the US geography.

    Segment-wise performance
    (Rs m) 4QFY14 1QFY15 Change
    Revenue break-up by service offerings
    Enterprise Application Services 12,973 13,714 5.7%
    Engineering and R&D services 13,647 14,937 9.5%
    Industry Application  Services 24,261 24,196 -0.3%
    Infrastructure Management Services 29,063 30,136 3.7%
    BPO 4,296 4,368 1.7%
    Revenue break-up by geography
    US  45,742 49,178 7.5%
    Europe 27,799 28,214 1.5%
    RoW 10,698 9,958 -6.9%
    Revenue by industry vertical
    Financial services 23,924 24,633 3.0%
    Manufacturing 26,620 28,214 6.0%
    Telecom & Media 7,497 7,599 1.4%
    Retail & CPG 7,160 8,298 15.9%
    Healthcare 8,592 8,560 -0.4%
    Energy & Public Sector 8,508 8,124 -4.5%
    Others 1,920 1,922 0.1%

  • At the operating level, wage hikes were the primary reason for the muted operating performance. The management has stated that the impact on margins due to wage hikes will be higher in the next quarter.

  • At the net level, the muted operating performance and a significant sequential increase in the tax rate weighed heavily on the bottomline. The net profit increased by just 2.1% QoQ.
What to expect?

At the current price of 1,570 the stock of HCL Tech is trading at 15.8 times its trailing twelve month (TTM) EPS.

The company’s performance was subdued in 1QFY15 but this does not really surprise us. IMS is clearly the only growth driver for the company. This division contributes about a third of the company’s revenues. While IMS continues to grow strongly; the core software services division is still in the doldrums. The combined software services revenues grew by just 1% QoQ in constant currency terms. The outlook remains muted on this front.

Even on the margin front, the prospects are not too bright. Wage hikes will continue to have an adverse impact going forward. While the company does not provide too many details about the wage hike cycle; its impact is quite clear in the numbers.

While the deal momentum remains strong in IMS; the software services division will remain a drag on the topline performance going forward. The management is relying on the recent traction that they have witnessed in digital technologies to drive growth. However, as deal sizes are still small in this space, it remains to be seen if the company’s software services division can scale up these opportunities quickly. We are not too optimistic on this front.

We have updated our financial estimates for the company from an FY17 perspective. Considering the growth prospects of the company as well as the valuations of the stock, we re-iterate our view that investors should not buy the stock at these levels.

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