HCL Tech remains top pick with target of Rs 630: Nomura

HCL Tech, the country's fourth largest software services exporter reported a rise of net profit by 41.6% quarter-on-quarter to Rs 854 crore in the quarter ended June 2012. The company's dollar revenues went up 3% to USD 1,079.6 million from USD 1047.9 YoY. In rupee terms, the revenues grew 13.5% to Rs 5,919 crore in the fourth quarter of FY12.

Ashwin Mehta, IT Analyst at Nomura India said HCL Tech remains their top pick with a target price of Rs 630 per share. According to him, client mining has showed positive progression in the last quarter and if it can sustain investor concerns, there could be further rerating of the stock. Here is the edited transcript of the interview on CNBC-TV18. Q: How much more can valuation support on the way up for HCL Technologies after yesterday's strong numbers?
A: HCL Tech has been our top pick within the sector. Our target price on the stock is Rs 630. Assuming that no major rerating of the stock happens, multiples are around 13 times FY14 earnings. That gives 23% upside from current levels.
I think one key parameter to watch there is client mining. It has shown a positive progression in this quarter and if it sustains some of the investor concerns which have been there in terms of either revenue outperformance or margin sustainability or cash conversion, it will fade and that could lead to further rerating in our view. Also read: HCL Tech Q4 profit rises over 42%; FX loss at $10.5m HCL Tech will reach out for new deals by Oct-Nov Q: What are you assuming in terms of valuations at that price target that you just setout?
A: We value it around 13 times on FY14 earnings. In terms of our earnings expectations we expect around 18% CAGR in the stock over the next two years. Q: Do you think it's possible that HCL Tech might continue to trade at a bit of a premium to Infosys and Wipro, just like it is doing today?
A: I think from a sustainable perspective, for it to trade at a premium to Infosys and Wipro it needs to replicate the excess which Infosys and TCS have shown in the past on client mining.
In that scenario, you would see sustainable revenue outperformance and if margin predictability sustains, you could have a replication of the Cognizant scenario here. Cognizant traded a 15-20% premium to Infosys despite a lower margin but, for higher growth and predictable margin.
_PAGEBREAK_ Q: What about Wipro, a lot of institutional investors are getting increasingly disappointed at the time it is taking to recover. Do you hear a lot of dissatisfaction from clients you speak to?
A: In terms of Wipro, our view has been that the growth lag will not be costless and that seems to be playing out with them having to increase frontend investments, sales investments, possibly acquire for relationships as well.
That will be the near-term pain in Wipro. But from a longer term perspective, the steps being taken are positive. While Wipro has been our least preferred bet within IT, I think on a fall we would relook at our view. Q: A lot of the midcap IT companies have done much better than their frontline peers in the last couple of quarters, something which the market is warming up to. Do you see any convergence in valuations between midcap IT and largecap IT?
A: I think if you look at the discounts, the discounts have narrowed between midcap IT and largecap IT and that is largely performance driven. Given the lower revenue bases of midcaps, it has been able to land up deals and closing some of the inefficiencies which were there on client mining and cross selling in terms of services.
That helped them in terms of growing better than some of the largecap names. In terms of names that we cover, we think the growth in some of those names like Hexaware would be better than the largecap names. Q: What do you do with Infosys now? It had serious damage at Rs 2,150. Is it supported by valuations here?
A: I think we would not play the turnaround hopes purely on valuations. There are some fundamental issues that we had highlighted earlier as well. They need to save share within the cost efficiency segment and they have mixed issues in terms of the discretionary portions not doing well for them.
That's a big piece of their portfolio, so unless they get a handle on that we would not be playing turnaround hopes. The stock could drift down in our view. In terms of upsides, we do not see material upsides. Our target price on the stock is around Rs 2,260.