HCL Infosystems: On slippery pitch

Pressure of low margins and uncertainty on the Nokia front do not suggest much upside for HCL Infosystems.

The HCL Infosystems stock has plunged 37 per cent in a year, while the Sensex has moved up over 51 per cent. One reason for this underperformance is that it was trading at a high valuation of 19 times trailing earnings last August, which corrected perhaps due to the nature of its business (commodity-centric).

Plus, the new agreement with Nokia indicated that HCL would not remain the exclusive distributor, which resulted in the stock losing 30 per cent on February 20, 2006.

Though mobile phone and computer penetration continues to grow rapidly, HCL largely remains a commodity player -- its net profit margin fell from over 4 per cent in FY04 to 2.9 per cent in FY05 and 2.5 per cent last year.

In the year ended June 2006, HCL posted a strong top line growth with consolidated sales surging 46.7 per cent y-o-y, following the 69 per cent growth in FY05.

Higher penetration has helped the company improve computer and mobile revenues by 19 per cent and 57 per cent, respectively.

However, operating profit growth was lower at 40.97 per cent, which resulted in margins declining 14 basis points to 3.32 per cent.

But segment margin (at the profit before interest and tax level) in the computer business slumped 167 basis points, though the telecommunication and office automation segment margin was up 16 basis points.

The latter business, which mainly consists of Nokia redistribution, accounted for 76.9 per cent of the company's consolidated sales in FY06.

Going forward, Nokia will add areas for direct billing and share equal volumes with HCL, which will have an impact on the latter's top line, though the management said higher volumes would offset the possible loss.

At about 10 times trailing earnings, the HCL stock may appear cheap, but low margins pressure and uncertainty on the Nokia front do not suggest much upside.

Thomas Cook: A mixed bag

Thomas Cook has been able to only partially leverage the traditional upturn witnessed in the travel business during the summer season for the quarter ended July 2006.

The company has seen its consolidated operating profit grow 15.55 per cent y-o-y to Rs 16.49 crore for the July quarter, compared with 42 per cent growth in its income from operations to Rs 49.73 crore.

Also, its operating profit margin plummeted 760 basis points y-o-y to 33.15 per cent in the last quarter.

Pressure on operating margins was due to staff cost jumping 56.6 per cent y-o-y to Rs 13.86 crore in the quarter.

A rise in the overhead appears inevitable, say analysts, given no signs of weakness in the current boom in the travel and hospitality industry. Also, the company's other expenditure rose 66.6 per cent y-o-y to Rs 17.6 crore for the July quarter.

Meanwhile, growth in its key travel and related services division was powered largely by strong demand for its tour packages at home. Profit of this division grew 29.4 per cent to Rs 20.11 crore in the quarter.

Besides, the financial services segment performed better during the quarter. The business is expected to expand aggressively in the medium term, once the company completes all the regulatory formalities relating to its merger with LKP Forex.

However, with the stock trading at about 31 times its estimated October 2006 earnings, further upside from the current levels seems limited.

Britannia: Crack in the cookie

Biscuit major Britannia's operating margins crumbled 800 basis points in the June quarter, thanks to a surge in costs. This came on top of a 500-basis point decline in margins in FY06.

However, much like in the March quarter, its top line managed to post a smart 25 per cent rise y-o-y. Nonetheless, a higher ratio of inputs and packaging materials -- up 920 basis points at 59 per cent, as also a big rise in other expenditure, resulted in the operating profit plunging 43 per cent y-o-y to Rs 32.6 crore.

The fall in net profit "� which was 22.5 per cent "� would have been much steeper (of 49 per cent) had it not been propped up by a much higher other income.

Britannia should be in a position to maintain the sales momentum at these levels given that consumers are capable of spending in a surging economy. However, stiff competition from national players such as ITC will make it difficult for Britannia to raise prices.

At the same time, it will need to maintain its spending on advertising and promotions in order to retain its market share. The lack of pricing power could, thus, continue to keep margins unattractive, even if prices of raw materials ease.

While earnings remained flat in FY06, the stock has soared 30 per cent since June, and trades at around 16 times estimated FY07 earnings.

While this is not cheap given that earnings growth should remain subdued, it is not demanding compared with its peers in the FMCG space, because of the poor margins.

With contributions from Amriteshwar Mathur and Shobhana Subramanian