Stock Review: HCL TECHNOLOGIES

HCL Tech's March 2011 quarter performance was stellar, with a near 5% volume growth boosted by traction in its infrastructure and software segments. What may also cheer investors is that the robust growth was accompanied by higher profitability. Margins are expected to further improve in the June quarter.
Over the past few quarters, HCL had reported better sales growth and a higher share of incremental revenue. The only missing link was the abysmal profitability of its operations compared with its peers.

During the previous quarter's results commentary, this column had underlined that HCL Tech's topline growth was largely at the expense of profitability. The company was not able to report incremental operating profit in the four quarters to December 2010 even though its incremental revenue grew by 20%.

The good news is that the management has taken steps to address this growth anomaly. HCL Tech reported 130 basis points improvement in operating margin at 14.4% during the March 2011 quarter, helped by cost rationalisation. CFO Anil Chanana expects further improvement of an equal magnitude in the June quarter.
This, however, demands sustainable expansion in profitability over the quarters since the company's current margin level is well below the 22-28% range of its bigger peers. Moreover, its margin is likely to be under pressure in the September quarter due to the annual salary increments in July.

But what is assuring is that HCL Tech has been a major beneficiary of the revival in the outsourcing demand over the past six quarters. According to Chanana, the company got over onethird of its revenue from new customers in 2010; in terms of the share of new customers in the total revenue, this is the highest among the top-four IT exporters. HCL Tech's peer group includes TCS, Infosys, and Wipro in the order of their revenue from IT business.

Also assuring is the fact that the faster revenue growth has not adversely impacted the time taken to collect outstanding sales. It, in fact, improved to 55 days in the March quarter from 61 days in the previous quarter. Following the results, HCL Tech's stock shot up by nearly 10% on Wednesday. This implies a trailing P/E of 23. Analysts think it may go up further if the growth in revenue and margin expansion is sustained in the coming quarters.