HCL Technologies

Beyond operations, lower depreciation and amortisation charges as well as halving of forex-related losses helped the company report a 60.5 per cent q-o-q rise in net profit for June 2009 quarter. This robust performance helped HCL in containing the decline in net profit to a mere 5.6 per cent in 2008-09--- profits were down 21 per cent in the first nine months.
structuring its operations for faster growth, which has reaped good results. In a bid to stay ahead of the industry and broad base its growth platform, HCL is continuing to focus on non-US markets, reduce dependence on any single vertical, service or geography and offer customers incremental value. However, in the near-term, analysts believe that there are challenges including from the company’s higher reliance on new deals for growth. As against its larger peers, HCL’s share of repeat business has been on a gradual decline. And although it announced new deals including from Sony and Nokia among others during the quarter, the undertone on big deals in future was not strong.

While resumption of business from existing clients has been the primary reason for outperformance (v/s expectations during quarter ended June 2009) at other tier 1 vendors, HCL mostly benefited from better performance on new deals. In this context, management’s negative outlook on deal flow is worrying. Also, IMS could have further margin headwinds, as the nature of new deals necessitate higher contracting. That the company’s software services business has seen its employee strength reduce q-o-q by 538 in June 2009 quarter on the back of a 396 qo-q decline in March 2009 quarter is perhaps some indicator, believe analysts. They however, also believe that while there is limited scope to further enhance utilisation levels the company could resort to just-in-time recruitments if needed.

Conclusion

For now, the challenges pertaining to weak demand and managing costs are likely to persist for Indian IT companies in the near-term. In the mediumterm though, the expected economic recovery in US and other global markets from early 2010 should improve visibility. For HCL Tech, on the back of better June quarter performance, most analysts have revised upwards their revenue and earnings estimates for 2009-10 and 2010-11, translating into an EPS of Rs 16.3 and Rs 23.2, respectively. However, at Rs 306, the stock, which is up by 22 per cent in the last six trading sessions and trades at 13.1 times its estimated 2010-11 earnings, is a bit expensive and can be considered on dips.

HCL Technologies surprised the Street by posting good numbers for June 2009 quarter. While revenue growth was helped by strong performance of its infrastructure services business, profit margins rose on the back of a tighter control over costs. However, the flip side is that concerns over demand and pricing persist. On its part, the company believes that its strategy of focussing on large deals, emphasis on offering new services and thrust on providing value to customers among others will help it emerge stronger and report industry leading growth, going ahead. Meanwhile, even as analysts have upped their estimates for 2009-10 and 2010-11, the stock looks a tad expensive at current levels. June quarter, a booster

The fifth largest Indian IT company, HCL Technologies has broadly three service segments classified as software, infrastructure management (IMS) and BPO. While the company caters to the needs of a host of sectors, its presence across the value chain (multi-service offerings) has helped it qualify for big multi-year outsourcing deals believe analysts—in 2007-08, the company bagged $1 billion worth of large deals and the same stood at $1.5 billion in the first nine months of 2008-09.

Higher revenues booked from new deals won in the first nine months (July to March) of 2008-09 have partly helped HCL report a 3.9 per cent quarter-on-quarter (q-o-q) growth in revenues (in dollar terms and on a constant currency basis) for the fourth quarter ended June 2009. The reported revenue growth though was higher at 7.6 per cent. Notably, volumes grew by about 2.7 per cent to some extent helped by higher number of billable days.

IMS, which accounted for 18 per cent of total revenues, reported a strong 25 per cent q-o-q growth. However, its EBIDTA margins fell by 260 basis points (bps) to 19.4 per cent, partly due to outsourcing of jobs worth $7 million to third parties. The BPO business (about 10 per cent of revenues) too saw margins slip, albeit by just 20 bps, mainly due to higher staff costs.
Notably, software services (roughly threefourths of total revenues) did reasonably well with revenues rising by 4.5 per cent in dollar terms, mainly helped by a 13 per cent sequential growth in the custom application business. More importantly, its EBIDTA margins expanded by 180 bps to 23.8 per cent. As the external environment conditions turned tougher, Indian IT companies have been focusing on cutting costs to preserve margins.

HCL, too, has been working on similar lines. Over the last six quarters, it has been able to increase its employee utilisation levels— it is up from 69.1 in December 2007 quarter to 74.1 per cent in March 2009 quarter and further to 76.2 per cent in June 2009 quarter – as well as lower the attrition levels across businesses. Likewise, companies (including HCL) have also focussed on gradually hiking the share of fixed-price contracts, which adds to margin visibility. Last but not the least, selling and general expenses have been kept under control, all of which have led to margin expansion in June quarter (on q-o-q basis) as well as in 2008-09.