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Software key to HCL Info’s fortunes

Nov 28, 2000

HCL Infosystems is primarily engaged in the computer hardware business that accounted for 85% of its total revenue in FY00. Apart from branded computers, it also deals in other products like printers, scanners, photocopiers, cellular phones and EPABX Systems. The company also offers software services for which it has achieved SEI CMM Level 4 during FY00. Surprisingly, growth in its software business witnessed a slow down during the year. While revenues from hardware business grew by 22%, software services business grew by a marginal 4%.

HCL Infosystems is the undisputed leader in the branded personal computer (PC) market with a share of 12.9% in volume terms and 18.6% in value terms. Due to extensive competition and price wars coupled with cheaper imports, operating margins in the hardware business have remained poor. However, in the last three years the company has maintained its profit margins in range of 4-5% in the hardware business.

The demand for branded PCs is expected to improve in future with more and more industries getting IT enabled. Also, the reduction in the excise duty has narrowed down the difference between branded and non-branded PCs and other related products. IDC estimates the Indian PC market to grow at a compounded annual growth rate (CAGR) of 38.7% in the next three years. HCL with its unique brand identity is likely to benefit with increasing demand for computers.

Financial Performance
Year ended June 30 FY97 FY98 FY99 FY00 4 yrs CAGR
Net Sales 5,924 6,559 8,934 10,654 21.6%
Total revenues 5,977 6,614 8,974 10,766 21.7%
Operating profits 360 377 816 850 33.2%
Depreciation 38 80 115 127 50.1%
Interest 322 89 96 52 -45.6%
Profit before tax 53 263 645 784 146.0%
Tax 2 2 60 54 229.2%
Profit after tax 51 262 349 731 142.6%

Key Ratios
Particulars FY97 FY98 FY99 FY00
Gross profit margin 6.1% 5.8% 9.1% 8.0%
Effective tax rate 2.8% 0.6% 9.3% 6.8%
Net profit margin 0.9% 4.0% 3.9% 6.9%
EPS (Rs) 1.6 8.2 11.0 22.9

The company is gradually moving towards providing software services in the areas of consulting, system integration, ERP implementation and software development in order to improve its bottomline growth. However, services provided by HCL are at the lower end of the value chain.

During the year, its wholly owned subsidiary HCL Infinet has started providing ISP services in 14 cities. It plans to extend this service to 42 cities by the year-end. The company plans to achieve a subscriber base of 100,000 within a year of launch. This will make it one of the largest ISPs in India. In the near future HCL Infinet plans to provide B2B and ASP (application service provider) services. This could go a long way in improving the business of the company.

We have projected an EPS growth of 23% for the year ended June 2001 on revenues of Rs 13 bn. HCL’s future profits growth would be driven by increasing contribution from software services business. This is expected to maintain its topline growth in the range of 25-30% in the next three years. At the current market price of Rs 242 the stock is trading at a P/E of 9 times its FY01 projected earnings.

The company’s future valuations depends on its ability to successfully offer higher value added services in the software segment and maintain its leadership position in the hardware segment in the face of increasing competition from the unorganised sector apart from branded players such as Compaq and IBM.

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