Stock Review: HCL technology

India's information and technology players are looking at new ways to boost profitability, as margins come under intense pressure. And to counter this, companies are boosting their SGA (selling and general administration) expenses substantially. SGA has become the new success mantra for the industry. Interestingly, over the last few quarters, HCL Technology, too, has expanded its SGA by 110 basis points to 15.2 per cent within five quarters. In absolute terms, the expenditure on SGA increased from Rs 430 crore in the first quarter of FY10 to Rs 590 crore in the second quarter of FY11.

The reason for boosting its sales drive is primarily due to the mismatch between revenue and profit growth. Over the last few months, HCL Technology hasn't been able to increase revenues and margins concurrently. According to a report by Motilal Oswal, HCL's earnings before interest, taxes, depreciation and amortisation (Ebitda) margin has declined from 22.1 per cent in September 2009 to 15.7 per cent in December 2010. In contrast, revenues have consistently grown at almost 30 per cent.

However, analysts believe the reason for this is due to factors like higher employee additions and SGA expenses. Analysts view this as investments and not expenses, as these measures will help the company improve realisations from clients over the next few quarters. SGA investments (as a proportion of revenue) are likely to decline, which will potentially expand margins by 75-100 basis points margin expansion. Also increase in utilisation levels to the historical average (since fourth quarter of FY07) can also contribute margin expansion of another 100 basis points.

Analysts believe this is already reflecting in the company's client metrics. For instance, HCL Technology's number of active clients increased by 16.4 per cent to 434 in December 2010, from 373 in September 2009. To put this in context, the absolute number of client additions was same in the case of both HCL and TCS at 60 clients, despite a much higher base at TCS (from 896 to 959).

Higher expenses on sales drive may help the company improve margins