Non-infra management services business growth picks up for HCL Technologies

While analysts could raise their FY14 earnings estimates marginally, sustained improvement in core software services business is key for its re-rating

HCL Technologies posted a robust set of numbers for the quarter ended December 31. Pick-up in non-IMS (Infrastructure management services) businesses, better than expected profits and margins (led by productivity gains) were the key highlights. Notably, the management remains confident of the road ahead.

Anil Chanana, chief financial officer, HCL Technologies says, “Our deal pipeline looks significantly better. And, we are seeing good traction in the rebid markets in both the US and Europe. We won 15 large deals in this quarter, with about half in the IMS business and the rest from non-IMS. We remain confident of the growth ahead as client budgets remain stable”.

Most analysts are positive on the company, given its strong growth visibility, good positioning in the IMS business and improving margins. While the stock scaled an all-time high on Thursday before closing at Rs 1,392, it still trades at 16.8 times FY14 estimated earnings or 7-14 per cent discount to Wipro (18 times) and Infosys (20 times), indicating room for upside.

Pick up in core IT services key to re-rating
HCL Technologies’ stock has continued to trade in the 15-16 times one-year forward price-to-earnings (P/E) band, despite posting strong performance consistently in the recent past. The key reasons for that were lower margins versus peers and also muted growth of core information technology services business (67 per cent of revenues).

While the company has expanded its Ebitda margins from 21.8 per cent level in September 2012 quarter to 26 per cent currently, the core software business has started picking up only in this quarter. Though the IMS business (a third of revenues) continues to grow at a fast pace, if the trend in core software services continues, the stock could see P/E re-rating, believe analysts.

Ankita Somani, research analyst -IT, Angel Broking, says, “HCL Technologies addressed the issue of lop-sided growth for this quarter atleast. While IMS business grew six per cent, the non-IMS business grew by 3.1 per cent sequentially versus one per cent growth over the past four quarters. If this trend sustains in the next quarter as well, we believe, re-rating of the scrip will kick-off.”  She has an ‘accumulate’ rating on the stock and is marginally raising the FY14 earnings estimates to factor in this quarter’s numbers.

Management attributes the good show of core business to better traction in alternative to application management (ALT ASM), Saas (software as a service) businesses along with good growth in the business process outsourcing (BPO) business. Financial services, manufacturing and utilities segments are all doing well. Going forward as well, management remains optimistic on sustaining all-round growth.

“We have made investments in new technologies and in BPO, which have started paying off. There is good momentum in the deal wins. Overall, we expect the non-IMS business to grow going forward though the figure may vary from quarter to quarter”, adds Chanana.

Q3: Strong show
For the quarter, revenues, up 2.8 per cent sequentially to Rs 8,184 crore, were largely in-line with Street estimates. However, lower selling and general expenditure (down 20 basis points sequentially to 12.5 per cent of sales) led to better than expected Ebitda margin. The margin contracted 30 basis points to 26 per cent and was pulled down by wage increases (70 basis points impact) and unfavourable currency (30 basis points). This was better than consensus Bloomberg expectations of 24.6 per cent Ebitda margins. The lower decline in margin is also due to spreading of wage impact, say ICICI Securities’ analysts. “Impact of wages was lower 70 basis points vs. an expected 120 basis points, with 30 basis points additional impact to come in each of Q3 and Q4 driven by a new reward policy”. However, even if the same is adjusted, margins are still better than Street expectations.

Lower forex losses of Rs 158 crore (versus Rs 236 crore in the September 2013 quarter) aided net profit, which grew 5.7 per cent sequentially to Rs 1,496 crore. Europe (up five per cent) and key verticals of financial services (up 2.1 per cent) and manufacturing (up 4.4 per cent) put up a good show in the quarter.

Notably, the order intake was also superior, say ICICI Securities’ analysts. “HCL Tech bagged deals in excess of $1 billion (15 transformational) for the fifth consecutive quarter. Importantly, 80 per cent of these bookings were from Fortune 500/Global 2000 customers.”