HCL's 'healthy' March numbers contain seeds of doubt

Billion-dollar deal wins not reflected in software services business; analysts expect margins to come off soon

HCL Technologies reported a healthy set of numbers for the March quarter, unlike Infosys. Despite this divergence in performance, it's difficult to shake off the question mark on the future of India's software services companies. While HCL's performance looks very good compared to Infosys, the days of double-digit growth for information technology (IT) companies are looking numbered. This is apparent from both HCL's commentary and numbers.

On the face of it, HCL Technologies is doing everything right. It is signing new deals, growing revenues and profits quarter after quarter. But a close look at the numbers suggests that as the industry is maturing, its contours are changing, too. For starters, though the company's overall dollar revenues have grown 3.2 per cent sequentially and 13.6 per cent annually, revenues from software services has grown a mere one per cent sequentially. Software services happen to be the traditional application and maintenance business and the company's $1-billion deal wins every quarter is clearly not reflected in this segment. And, 90 per cent of these are from the rebid market and 50 per cent are integrated deals.

Revenue growth has largely been driven by infrastructure services, which has grown 8.6 per cent sequentially. The company's chief financial officer, Anil Chanana, conveyed that though some discretionary work is also involved in the transformational deals, standalone discretionary deals are down. This implies Infosys is not entirely off the mark.

The other reason that analysts are cautious on HCL Tech is its margin profile. For long, these were nothing to write home about but this has changed over the last four quarters. The company's held on to an earnings before interest and tax margin of 19.9 per cent in the March quarter, too. From hereon it is widely believed that the margins will no longer increase but decline. So far, the company has improved margins by steadily increasing utilisation and keeping a very tight bench.

In the March quarter, HCL's blended utilisation (excluding trainees) stood at 84 per cent. The company has improved margins by squeezing productivity to the last drop. Sequentially, the company's employee headcount is down from 85,194 to 84,403, despite large deal wins. Going forward, the company will have to recruit people and that would have an impact on margins. Emkay Global is building in a margin decline for the company, even as it expects revenue to clock cumulative quarterly growth rate of 3.5 per cent. Things are clearly getting tough for Indian vendors.