Why is HCL Tech's PE multiple not reflecting good earnings?

HCL Technologies has risen over 60 percent in the last one year, and its EBIT (earnings before interest, taxes) margins are up 400bps since Jan 2012, but interestingly the P/E multiple has not kept pace with the EPS (earning per share) upgrades.

"Within the P = P/E*EPS equation, we note that robust FY13 EPS upgrade of 40 percent has alone accounted for 80 percent of the stock move with valuation

(P/E) upgrade contributing just 11 percent (or just 20 percent of the 12-month stock move)," noted JP Morgan analysts Viju George and Amit Sharma.

Despite the strong growth at HCL Tech, the recent management changes are clearly among the key concerns on the street.

The company last month elevated Anant Gupta, its COO and President to the post of CEO, while industry veteran Vineet Nayar will stay on as vice chairman and joint MD till July and VC there after.

Gupta has played a key role in driving growth in the infrastructure management vertical, but the market is more concerned about the software services business, which, compared to infra management has rather had a muted growth, the JP Morgan analysts point out.

Further more, how well the company performs under a new CEO will also be an important marker as this shapes P/E multiples one year out, George and Sharma say.

The analysts say that there is also a section of the street "not fully assured of the soundness of HCL Tech's operating practices," which might also partly explain an inability of the stock to achieve P/E breakout.  According to a media report last month, several analysts and executives at rival IT firms had raised concerns on alleged "unethical practices" at HCL’s European operations. HCL Tech has denied any wrongdoings.

"Our view is HCL Tech is more aggressive in pricing and more flexible in contract restructuring. But this reflects in its margins/ROCE/ROE profile and thus is ideally duly factored in its valuations," they said.

JP Morgan has an "overweight" rating on HCL Tech with a target price of Rs 775. Its 12-month forward multiple remains at 12-13 times.

HCL Tech shares were up 1 percent at Rs 712.70 on NSE in morning trade.