19 October 2011 1QFY12 Results Update Sector: Technology BSE SENSEX S&P CNX 16,748 5,038 Bloomberg HCLT IN Equity Shares (m) 700.9 52-Week Range (INR) 528/360 1,6,12 Rel. Perf. (%) 4/-1/7 M.Cap. (INR b) 281.2 M.Cap. (USD b) 5.7 CMP: INR401 TP: INR516 Buy * After ESOP charges; # Axon consolidated in December 2008 Volume growth lower than expected; but environment outlook positive: HCL Tech reported 4% volume growth in its core software business (v/s our estimate of 6.3%) and 5.1% volume growth overall. While this is lower than our estimates, large deal wins indicate acceleration in growth in the quarters ahead. The management indicated that they were seeing a strong pipeline of deals that are likely to close in OND 2011. The company is also not seeing any budget cuts for CY12; it expects IT budgets to remain flat. This should help drive stronger growth in 2012. EBIT margin decline suppressed by a weak INR and 120bp improvement in realizations: HCL Tech had headwinds during the quarter in the form of salary hike (83% of the wage bill), fresher hiring driving lower utilization and SG&A investments. However, these headwinds were offset by a 400bp depreciation in the INR, a 120bp improvement in realizations and efficiency gains during the quarter. Our core thesis is intact: Our core thesis remains intact, with management commentary indicating a strong deal pipeline, most of which is likely to be closed in OND 2011. Moreover, the company signed 12 multi-year, multiservice transformational deals during the quarter. Also, HCL Tech has seen strong additions across revenue buckets, indicating good client mining. Valuation and view: The stock trades at 13.4x FY12E and 11.7x FY13E EPS. Our target price of INR516 discounts FY13E EPS of INR34.4 by 15x. Maintain Buy. Nitin Padmanabhan (Nitin.Padmanabhan@MotilalOswal.com) Tel: +91 22 3982 5426 Ashish Chopra (Ashish.Chopra@MotilalOswal.com); Tel: +91 22 3982 5424
Volume growth lower than expected; large deal wins indicate traction in the quarters ahead HCL Tech reported 4% volume growth in its core software business (v/s our estimate of 6.3%) and 5.1% volume growth overall. While this is lower than we had expected, large deal wins indicate acceleration in growth in the quarters ahead. Our optimism stems from the following: The company closed deals with a TCV of USD2.65b in CY10 v/s USD1.5b in the previous year. HCL Tech is ranked among the top-6 winners of deals having TCV >USD25m across Americas, Europe and Asia Pacific by TPI alongside the likes of Accenture and IBM for 9MCY11. TPI estimates the TCV of restructuring-based deals that are likely to close in OND 2011 at USD8b (v/s USD5b in JAS quarter). HCL Tech sees a strong deal pipeline based on these restructuring deals and expects 65% of its deal funnel, which comprises of run the business deals (RTB), to be awarded by the end of December. HCL Tech expects IT budgets to remain flat in CY12. HCL Tech 1QFY12: Actual v/s estimates 1QFY12 4QFY11 QoQ 1QFY11 YoY Actual Est. (%) (%) Revenues (INR m) 46,513 45,997 42,995 8.2 36,116 28.8 EBITDA (INR m)* 7,764 7,258 7,725 0.5 5,632 37.9 EBITDA (%) 16.7 15.8 18.0-128bp 15.6 110bp Adj. PAT (INR m) 4,800 4,256 4,913-2.3 3,004 59.8 Revenues (USD m) 1,002 1,013 963 4.1 804 24.7 *: including ESOP charges Revising estimates to factor in a weaker INR and lower USD revenue growth in 1QFY12 We revise our INR assumptions for FY12 and FY13 in line with Infosys and TCS. Since HCL Tech has a June year-ending, the average rates appear different v/s peers. We also factor in the impact of lower than estimated USD revenue growth and hedge losses as guided by the company (assuming the USD remains flat at INR49.77). Factoring in a weaker INR and differential in USD revenue growth in 1QFY12 Change in Estiamtes Revised Earlier Change (%) FY12E FY13E FY12E FY13E FY12E FY13E INR/USD 47.7 45.4 45.1 45.0 5.8 0.9 USD Revenue - m 4,350 5,177 4,428 5,235-1.8-1.1 EBIT Margin (%) 14.0 13.3 13.7 13.4 31bp -2bp EPS - INR 29.9 34.4 29.3 34.9 2.1-1.5 19 October 2011 2
Contributors to EBIT margin movement Salary hikes SG&A Utilization Efficiency gains Currency EBIT % movement -200bp -53bp -45bp 84bp 102bp -112bp EBIT margin decline suppressed by a weak INR and 120bp improvement in realizations HCL Tech had headwinds during the quarter in the form of salary hike (83% of the wage bill), fresher hiring driving lower utilization and SG&A investments. These headwinds negatively impacted HCL Tech's EBIT margin by 200bp, 45bp and 53bp, respectively. However, these headwinds were offset by a 400bp depreciation in the INR (102bp positive impact on EBIT margin), a 120bp improvement in realizations and efficiencies, together aiding EBIT margin by 84bp. Core thesis: Industry leading revenue growth, visibility and history of execution Our core thesis remains intact, with management commentary indicating a strong deal pipeline, most of which is likely to be closed in OND 2011. Moreover, the company signed 12 multi-year, multi-service transformational deals during the quarter. Also, HCL Tech has seen strong additions across revenue buckets, indicating good client mining. HCL Tech has been able to consistently acquire clients and increase the revenue contribution per client. USD revenue up 5.3% QoQ against our estimate of 6%, volumes disappoint Nor of USDm clients (LTM) FY12 FY11 Chg. 1Q 4Q USD1m + 349 332 17 USD5m + 135 126 9 USD10m + 79 73 6 USD20m + 37 35 2 USD30m + 23 22 1 USD40m + 11 10 1 USD50m + 9 9 0 USD100m + 1 1 0 1.7 1.6 1.7 1QFY10 2QFY10 3QFY10 Average revenue per client (USD m) 1.8 1.9 2.0 2.0 2.1 2.1 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11 1QFY12 Revenue growth - the slice-n-dice HCL Tech added USD39m in incremental revenue in 1QFY12 v/s USD48m in 4QFY11. 91% of the incremental revenue was contributed by the US geography. US majorly drove incremental revenues during the quarter Incremental Revenue 1QFY12 Contr to inc rev % US 36 91 Europe 6 15 RoW -2-6 Total 39 100 From a vertical perspective, Manufacturing & Hitech and Retail accounted for 74% of the incremental revenue added. The Telecom vertical continues to be weak and the management does not expect any improvement in the near term. 19 October 2011 3
Manufacturing & Hitech and Retail were the key growth verticals, Telecom continues to be weak Incremental Revenue 1QFY12 Contr to inc rev % Banking, FS & Insurance (BFSI) 1 3 Hi-tech - Manufacturing 20 51 Telecom -2-6 Retail 9 23 Media Publishing & Entertainment (MPE) 0-1 Life Sciences 0 0 Energy Utilities - Public Sector 0 1 Others 11 29 Total 39 100 From a horizontal perspective, Engineering & R&D Services and Custom Application Development accounted for 85% of the incremental revenue during the quarter. Engineering & R&D and ADM the growth highlights among services Incremental Revenue 1QFY12 Contr to inc rev % Enterprise Application Services -3-8 Engineering and R&D Services 15 38 Custom application development (ADM) 18 47 Infrastructure Services (IMS) 10 27 BPO Services -1-3 Total 39 100 Other results highlights DSO days were 54 v/s 53 in 4QFY11. The company added 66 new clients during the quarter. Active client relationships at the end of the quarter were 480 v/s 467 in 4QFY11. Utilization including trainees declined 280bp QoQ to 69.7% on addition of 3,000 freshers in 1QFY12 and a similar number in 4QFY11. Net cash at the end of the quarter was USD24m (USD466m cash and USD442m borrowings). Contribution from fixed price contracts increased 150bp QoQ to 44%. Net employee addition was 3,474 during the quarter. LTM attrition in IT Services was 15.9%. Hedges increased to USD713m (from USD390m in 1Q). OCI losses on the balance sheet stand at USD18.7m (assuming INR/USD at 49.77), spread over 12 months (2QFY12: USD7.3m, 3QFY12: USD5.8m, 4QFY12: USD4.1m and 1QFY13: USD1.8m). The company is seeing a large funnel in BPO, which is likely to drive growth for the segment post 3QFY12, by when it expects to turn EBITDA neutral. 19 October 2011 4
Growth Comparison matrix HCLT TCS INFY USD Revenue 4.1 4.7 4.5 Volume (overall) 5.1 6.3 4.4 Geography North America 6.8 5.7 6.2 Europe 2.2 6.3 0.8 ROW -1.5 5.5 7.3 Industry BFSI 0.5 5.2 4.4 Manufacturing 7.8 8.0 3.5 Retail 12.0 9.2 5.5 Telecom -2.8-4.3 6.2 Energy and Utilities 0.3 18.5 8.2 Services ADM 6.0 1.3 5.3 EAS/Pkg Impl -1.4 7.6 2.4 IMS 4.5 5.8 2.7 BPO -2.3 4.7 4.5 Operating Metrics QOQ growth (%) 4QFY09 1QFY10 2QFY10 3QFY10 4QFY10 1QFY11 2QFY11 3QFY11 4QFY11 1QFY12 Service Line wise Enterprise application services 3.6 (3.7) 5.8 0.4 11.7 6.5 5.5 6.3 2.8 (1.4) Engineering and R&D Services (5.1) 0.0 (0.4) 10.9 11.1 4.0 6.4 1.3 5.9 8.8 Custom Application(Industry Solutions) 12.5 7.3 2.8 3.0 6.6 15.2 9.2 6.5 4.6 6.0 Infrastructure Services 25.4 14.4 8.2 14.9 8.6 8.5 9.9 8.6 10.2 4.5 BPO Services 4.4 (0.5) (2.1) (9.2) (12.2) 5.5 2.1 0.3 (4.5) (2.3) Vertical wise BFSI 13.1 10.0 2.6 2.7 5.1 10.3 4.9 12.7 4.5 0.5 Hitech-Manufacturing 9.7 (8.0) (3.4) 9.6 10.1 8.6 7.1 6.7 7.9 7.8 Telecom 11.1 7.9 (0.5) (2.5) 1.2 10.0 5.5 0.9 (7.0) (2.8) Retail 2.9 10.1 18.2 (1.5) 17.7 13.0 15.1 1.2 (4.4) 12.0 Media Publishing and Entertainment (MPE) 20.5 26.0 9.5 15.3 0.9 1.6 5.9 2.7 13.3 (0.3) Life Sciences 9.3 3.8 16.4 9.5 17.7 11.6 7.5 0.8 4.0 0.1 Energy utilities public sector (8.1) (7.2) 11.0 0.8 6.1 7.4 13.8 7.3 19.7 0.3 Others (12.7) 16.7 0.1 8.6 6.0 5.5 3.9 2.2 7.2 20.5 Geography wise US 3.9 3.4 2.2 7.8 11.3 2.8 5.8 0.6 5.5 6.8 Europe 11.1 5.6 5.2 (4.9) (0.8) 18.3 7.1 7.4 5.7 2.2 RoW 18.9 1.3 5.1 16.0 8.5 20.0 14.5 21.4 4.2 (1.5) Client wise Top 5 clients (2.4) (4.3) (2.0) 3.9 7.1 9.0 2.0 2.1 0.1 3.4 Top 10 clients (2.5) (2.3) (0.4) 3.5 8.1 9.0 6.3 4.2 2.8 2.0 Top 20 clients (0.8) (1.6) 0.2 4.3 7.7 9.0 7.5 4.7 2.7 0.8 19 October 2011 5
: an investment profile Company description is one of the largest IT services companies in India, employing over 80,000 people. It is a leader in Remote Infrastructure Management, Engineering and R&D Services, and has sizeable BPO, Enterprise Solutions and ADM practices. Key investment arguments Fastest growth trajectory in the infrastructure management space, the strongest growth segment for Indian IT. A comprehensive IT Services company, with a wide portfolio of services including R&D, Enterprise, BPO, Infrastructure Management and Enterprise Application Services. The company has made inroads into non-linear pricing models. Strong presence in Engineering and R&D, which is at the high end of technology. Key investment risks YoY decline in margins on aggressive growth pursuit. Slower than anticipated ramp-up in large deals leading to moderation in revenue growth. Appreciation of the rupee and cross-currency movements could hamper profitability. Recent developments HCL Tech won 12 transformational deals in 1QFY12. HCL Tech featured amongst TPI's Global 6 IT Services providers by TCVs awarded, across all the three regions of the world. Valuation and view Expect INR revenue CAGR of 20.8% and earnings CAGR of 22.2% over FY11-13. Valuations at 13.4x FY12E and 11.7x FY13E earnings (post ESOP charges). Maintain Buy. Sector view In the last few months, increasingly weak macro economic data has been emanating from both the US and Europe, which implies deceleration in growth for Indian IT Services. While CY12 budgets are yet to be hinted, we expect a moderation in growth across the sector, resulting from a possible 3-4% cut in budgets as in 2003 (v/s 6-8% in CY08). We reckon frontline Indian IT companies would be better placed to sail through the near term adversities mentioned above. Niche IT/ITeS services companies with strong business models are also likely to be better placed to face uncertainties in the near term. Comparative valuations HCLT TCS Wipro P/E (x) FY12E 13.4 19.6 15.8 FY13E 11.7 17.3 14.5 P/BV (x) FY12E 2.7 6.3 3 FY13E 2.3 5.1 2.5 EV/Sales (x) FY12E 1.3 4.1 2.2 FY13E 1.1 3.5 1.9 EV/EBITDA (x) FY12E 7.5 13.7 11.1 FY13E 6.7 12.4 9.8 EPS: MOSL forecast v/s consensus (INR) MOSL Consensus Variation Forecast* Forecast (%) FY12 29.9 30.5-1.9 FY13 34.4 36.2-5.0 * After including ESOP charges Target Price and Recommendation Current Target Upside Reco. Price (INR) Price (INR) (%) 401 516 28.7 Buy Stock performance (1 year) Shareholding pattern (%) Jun-11 Mar-11 Jun-10 Promoter 64.4 64.7 65.3 Domestic Inst 6.1 6.0 5.2 Foreign 23.0 23.1 22.9 Others 6.5 6.3 6.5 Sensex - Rebased 540 480 420 360 300 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 19 October 2011 6
Financials and Valuation 19 October 2011 7
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