Aditya Birla Money neutral on HCL Tech; target Rs 774.8

Aditya Birla Money has maintained a neutral rating on HCL Technologies with a target price of Rs 774.8, in its April 18, 2013 research report.

"HCL Tech continued to post a healthy top-line expansion of 3.2 percent QoQ to 1190.8 mn from 1154.3 mn and a 13.6 percent YoY growth from 1047.9 mn. In rupee terms, it grew by 2.4 percent QoQ to Rs 64.24 bn from Rs 62.73 bn. On service wise, IMS (Infrastructure Management Services), continued to lead the growth engine, inflated by 8.6 percent and contributes ~30 percent of sales vs 15 percent in Q309. On industry basis, Manufacturing led the pack (7.7 percent), followed by Telecom (3.3 percent) and Energy 13.5 percent. On geographical mix, Europe (4.6 percent) and US (3.5 percent) grew the most (QoQ USD  terms).

EBITDA improved by 1.6 percent to Rs 14.39 bn, with a slight dip in margin of 18 bps to 22.4 percent on QoQ basis. Improved efficiencies & better cost management helped them to maintain their margins. However, HCL’s low-hanging fruits are nearing peak levels a) Utilisation (80 percent vs comfortable 75-76 percent) and b) SG&A (13.3 percent in 9MFY13 vs 14-15 percent range in FY10-FY12). On YoY, EBITDA increased by 50.1 percent.

PAT improved by 7.8 percent to Rs 10.39 bn from Rs 9.65 bn (QoQ) and 72.5 percent growth on YoY basis.

Strong order wins continue: HCL Tech had yet another quarter of healthy order wins worth TCV of USD 1bn in large multi-year transformational deals. In that, over 90 percent of the deals were from restructuring market and more than 50 percent were from integrated deals (i.e., IMS + BPO or IMS + Application developments, etc.,). As per the management and TPI index Q1CY13 report, restructuring deals remained stable on QoQ basis, whereas new scope deals are hard to come by and slowly converging towards restructuring deals

IMS dependent or overdependence: IMS has been the major differentiator and resilient segment for HCL segment since FY08. It has substantially grown from ~15 percent of sales (FY08) to ~30 percent of sales (Q313), at a CAGR (FY08-FY13E) of ~35 percent vs non-IMS grew by 18.6 percent. On incremental revenues basis, Non-IMS segment used to contribute ~72 percent, whereas IMS ~28 percent. However, strong order bookings in the last 6-12 months on restructuring deals resulted in ~50 percent of the incremental revenue contribution from IMS ( ~48 percent growth for IMS and ~45 percent de-growth in FY13E) and is likely to enlarge further in the near future as more and more deals signed in this space. We believe that this strong momentum and order bookings in IMS space would help HCL Tech to outgrow industry average, but increasing single service concentration would emerge as a cause of concern in the medium term.

Outlook & Valuation: The results were slightly above estimates on margin front and PAT front. Another USD 1bn order win this quarter depicted the management optimism in the environment and continued to remain confident of maintaining the EBIT margin at 18-19 percent through strong execution. However, we remain little skeptic on the margin front as available levers seems to have near peaked and concerns on the non-IMS incremental revenue growth. We revise our earnings upwards by 2 percent and 3.4 percent for FY13E and FY14E to factor in the better than expected execution.

Currently, HCL trades at a consolidated P/E of 12.5x on its FY14E earnings of Rs 60.2. Market has richly rewarded (~70 percent up since apr’12) HCL Tech for their a) strong revenue visibility & large restructuring opportunities b) continuous OPM improvement and c) healthy free cash flow & cash conversion ratio. We believe that quality of Non-IMS incremental growth & limited margin levers would be a cause of concern in the medium term. We downgrade & value HCL at 12x on its one-year forward earnings with revised target price of Rs 774.8 and reduce our rating to Neutral from buy," says Aditya Birla Money research report.

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