The company’s Q2 performance was on a par with peers, the stock’s performance hinges on its ability to sustain growth and bag large orders.
HCL Tech, India’s fourth-largest software services firm, didn’t see the upswing expected from a depreciating rupee, which the Street was hoping for after Infosys’ strong performance reported last week. Also, volume growth was below expectations. These, coupled with continued global concerns (which are said to be consolidating) led to a sharp eight per cent fall in HCL Tech’s and TCS’ scrips, against a 1.8 per cent BSE Sensex dip on Tuesday.
The sharp fall can be partly attributed to the outperformance of the stocks (versus Sensex) by 12.5 per cent and eight per cent, respectively, last month (Infosys was up 14 per cent), mirroring the expected benefits for IT firms from the rupee’s depreciation. Going ahead, HCL’s management sounds confident and hopes to get a decent chunk of large IT outsourcing deals that will be up for grabs in the next few months.
| HOW THEY STACK UP | |||
| In Rs crore | TCS | Infosys | HCL Tech |
| Sales | 11,633 | 8,099 | 4,651 |
| % change q-o-q | 7.7 | 8.2 | 8.2 |
| Ebit (%) | 27.1 | 28.2 | 14.3 |
| Bps chg q-o-q | 90 | 208 | -120 |
| Net profit | 2,301 | 1,906 | 497 |
| % change q-o-q | -4.7 | 10.7 | -2.7 |
| EPS (Rs) | 11.7 | 33.4 | 28.4 |
| All figures are consolidated for the September 2011 quarter; q-o-q is quarter-on-quarter; Source: Companies, CapitaLine Plus | |||
SEPTEMBER QUARTER
Beneath the chatter though, HCL Tech’s performance stayed on par with peers. Like its larger peers, TCS and Infosys, HCL’s rupee revenues also grew by eight per cent quarter-on-quarter on the back of about five per cent increase in volumes. A cross currency impact of 100 basis points restricted the dollar-denominated revenue growth to a more modest 4.1 per cent sequentially. The company saw realisation gains of about 1.2 per cent, based mainly on productivity gains with no change in pricing, according to Vineet Nayar, vice-chairman and CEO, HCL Technologies.
The earnings before interest and tax (EBIT) margin contraction was restricted to 120 basis points sequential, against a guidance of 300 basis points narrowing because of salary increases undertaken this quarter as well as new hiring. The wage impact, however, was countered by 100 basis points positive currency tailwind and 75 basis points of productivity improvements. Consequently, its net profit was 2.7 per cent lower than the previous quarter at Rs 496.7 crore. On a broader level, HCL’s performance for the quarter largely reflected the trend of its bigger peers.
On a vertical basis, financial services continued to show moderate growth. On a constant currency basis, it grew by two per cent sequentially similar to last quarter, although HCL’s management emphasised on its robust 24 per cent growth over the same period last year. Manufacturing revenues showed robust growth, both sequentially and year-on-year, while telecom revenues continued to struggle as was the case with some of its peers. The currency moves affected revenues from Europe, which grew at a modest two per cent sequentially; excluding the currency impact, revenue growth was better at 5.6 per cent, according to management.
Revenues from the creamy Enterprise Application Service stream slowed by 1.4 per cent sequentially, which needs to be watched given the higher margins the segment commands. On the other hand, engineering services and custom applications bounced up strongly, showing between nine per cent and six per cent growth, respectively over last quarter. Infrastructure services grew at about 4.5 per cent and about 37.5 per cent year-on-year.
OUTLOOK
The company has seen strong growth with its quarterly dollar revenues doubling in the last three years and crossing one billion this quarter. However, after a slower volume growth of 3.9 per cent sequentially last quarter, management had indicated that the second half of 2011 would be more promising with a larger proportion back-ended to the last quarter of the calendar year. The company signed 12 transformational deals this quarter and volumes have picked up, but not dramatically. However, Nayar reiterates that the outlook hasn’t changed, with strong deal momentum expected this quarter. This is expected to be fuelled by new outsourcers (mainly from Europe) who are looking to reduce their so-called ‘run the business’ operational costs, spinning off a vendor churn and the total pie could touch $8 billion, according to a TPI report.
However, it isn’t as sanguine as this suggests. While Nayar was confident about spending for this year being on track, he also reiterated concerns on the impact of the global economic situation on client spending decisions going ahead. “January 2012 will be key as the ‘run the business’ spends will taper off by then and companies will take a call on budgets for discretionary spending then,” he said. It will, thus, be interesting to see how these pan out and, how much of the new outsourcing deals HCL is able to corner.
On the currency front, the company hedges about five months of its cash inflows and has a current position of $713 million (including a hedge of $180 million of balance-sheet exposure) at about Rs 48.35 with options between Rs 46 and Rs 48. “Given its relatively lower hedge position, HCL Tech could benefit further from the depreciating rupee”, say analysts.
HCL’s stock trades at 13 times FY12 and 11 times FY13 EPS estimates. While prima facie this is attractive compared to peers TCS and Infosys (19-17 times), HCL is visibly smaller in size and commands lower margins than its peers, which justify the lower valuations. Given the cautiously optimistic outlook for the sector, IT stocks should continue to outperform broader markets with HCL reflecting the sectoral trend.
