Buy HCL Tech, hold Wipro: BP Equities

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Buy HCL Tech, hold Wipro: BP Equities

BP Equities is bullish on HCL Tech and has recommended buy rating on the stock with a target of Rs 476 in its November 30, 2011 research report.

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BP Equities is bullish on HCL Tech and has recommended buy rating on the stock with a target of Rs 476 in its November 30, 2011 research report.

"We recommend HCL Tech over Wipro considering its high revenue visibility (despite uncertain macroeconomic environment),. The company has won significant deals in the past and has a stronger deal pipeline of ~US$ 2 bn. However, Wipro Ltd's performance since the last many quarters has been lackluster and we expect the company to take few more quarters to deliver growth in line with the industry. Moreover higher forex exposure will impact revenue growth and margins going forward."

"HCL Tech has signed 12 multi year, multi service transformational deals in Sep 2011 quarter and management has indicated a stronger deal pipeline going forward, which the company is likely to close in OND 2011. HCL Tech is eyeing on vendor churning exercise (whereby overseas clients are looking for new vendors to renew their contracts) to derive growth. According to TPI (Technology Partners International) the total size of deals on offer (for renewal) is as large as US$8 bn primarily from continental Europe. HCL Tech has strong presence in Europe (after AXON acquisition) thus we see it as a big growth driver for the company going forward. HCL Tech was also featured amongst TPI's Global 6 IT Services providers by Total Contract Value (TCVs) awarded, across all the three regions of the world."

HCL to gain most from Rupee depreciation while Wipro to be highest looser: INR has depreciated significantly against US$ (6.1% in since Oct'11 and16.9% since July'11) and companies with lower hedges are going to benefit the most (due to lower forex losses) from INR depreciation. HCL Tech has total hedges of US$713 mn (Options booked b/w Rs 48.3/$ - Rs 49.7/$) which is around 20% of FY11 revenues while Wipro has total hedges of $1.5 bn (30.6% of total revenues. We believe that HCL Tech will benefit the most from rupee depreciation and Wipro (which realizes forex gain/loss on the top line) will face the heat going forward.

Revenue per employee highest for HCL Tech, whereas least for Wipro Ltd: HCL Tech has largely outperformed its peers in terms of revenues per employee with lowest rev/emp in 2006 to highest in 2011. HCL Tech revenue per employee stands at $12,477/emp as compared to Infosys's $12,311/emp, TCS $11,758/emp and lowest among all Wipro $11,178/emp. HCL Tech has been able to achieve better efficiency through just in time hiring strategy and hiring more of lateral employees (which can be directly put under billing cycle). Going forward we believe that HCL Tech will be able to convert its high revenue per employee into profits in a reasonable timeframe primarily due to lower forex losses, which dented profits earlier.

Pricing environment stable for HCL Tech, while Wipro reported pricing decline in Q2 FY12: Pricing environment has been stable for HCL Tech and management too sees no pricing pressure from clients going forward. HCL Tech has reported 1.2% improvement in realizations in Q1 FY12 which we believe to remain stable in the coming quarters. Wipro on the other hand which struggled on the pricing front, has reported 4% decline in offshore pricing due to closure of some large project (which requires more efforts which cannot be billed).

Utilization set to improve for HCL Tech, while it will remain flat for Wipro Ltd: HCL Tech utilization stands at 69.7% for Sep'11 which is at lower levels as compared to 76.4% for TCS and 76.1% for Wipro in Sep'11. We believe that TCS and Wipro are operating at peak utilizations levels and scope for improvement is limited, whereas HCL Tech has more room for improvement (with more laterals additions) in utilization, which can improve margins going forward.

HCL Tech available at attractive valuation as compared to Wipro Ltd: HCL Tech trades at a FY12E and FY13E P/E of 12.1x and 10.7x which is lowest amongst tier-1 peers. We believe that HCL Tech trades at a pretty attractive valuation considering its strong deal pipeline and robust revenue visibility going forward. We maintain our "BUY" rating on the stock and give a price target of Rs 476 (upside of 21.8%) ~13x FY13E earnings. Wipro on the other hand trades at a FY12E and FY13E P/E of 15.7x and 14.0x, which we believe is fully valued considering its lackluster performance since the last few quarters, lower revenue visibility and higher forex exposure. We believe the company will take another 2-3 quarters more to return back on track, hence we will have to wait and watch for the performance of the new management team. We maintain our "Hold" rating on the stock and give a price target of Rs 386.9 (upside of 3.5%) which is ~15x FY13E earnings.

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