HCL Technologies: Buy

Top tier IT companies have delivered very different growth rates in the last 12-18 months.

HCL Technologies (HCL) has been a consistent performer in this period, outpacing peers such as Infosys and Wipro in a variety of aspects.

Investors with a one-two year perspective can consider buying the stock as it enjoys potentially sound business prospects and is still available at attractive valuation levels.

Strong deal momentum, healthy large-client additions, robust performance in key operating factors and a broad-based growth across segments over the past couple of years are key positives for the company.

A tight rein over costs has also helped the company maintain margins. HCL has also been a beneficiary of vendor rationalisation undertaken by large clients overseas.

At Rs 504, the share trades at 14 times its likely per share earnings for FY13. This is at a discount to peers such as Infosys and TCS, making for a reasonably attractive entry point.

In the nine months of FY-12, the company saw its revenues rise by 28.8 per cent over the same period in FY-11 to Rs 15112.4 crore, while net profits increased by 41.5 per cent to Rs 1672.1 crore.

On both counts, the growth rates are among the highest in the industry.

Healthy DEAL PIPELINE

HCL has a healthy pipeline of deals, won over the past couple of quarters. In the last six months, the company has won deals worth $2.5 billion, giving it substantial revenue visibility in a tough macroeconomic scenario.

Large-client additions have come at a steady pace for the company. Over the past one year, three customers have been added in the $100 million category, two in the $50 million band and 10 in the $30-40 million buckets.

This clearly indicates that the company has been able to win a fair share of large deals on offer and is even getting past Indian peers in the process. Also, in cases of vendor consolidation by large clients, HCL has more often than not been the winner.

The company's repeat business percentage too has been rising steadily over the past four quarters and is now at 94.9 per cent. This means that HCL has been able to mine existing clients quite well.

The company's largest vertical — manufacturing (29 per cent of revenues), has been growing at a pace that is faster than the company's revenue growth rate over the past year.

Broad-based growth

Financial services (24 per cent of revenues) has expanded at or marginally lower than the overall rate. Smaller verticals such as healthcare, energy and utilities too have grown at a faster pace than the overall rate.

From a service-mix point of view, applications and infrastructure services and, to some extent, engineering-services have grown at a fair pace.

Taken together, these points suggest that HCL's growth has a good blend to it.

But the company has not made significant strides in tapping into discretionary spends of clients in high-margin areas such as enterprise applications that are growing at a pace slower than the overall rate. In the recent quarter, HCL has made a start and it remains to be seen if the momentum will be sustained as it is important from a margin expansion point of view.

Operational positives

HCL has reduced the proportion of revenues spent as direct cost (including wages) from 68.3 per cent in the nine months ended FY-11 to 67.6 per cent so far this fiscal.

Also, selling expenses, as a proportion of sales, have reduced from 15.7 percent to 14.7 percent.

The company's proportion of revenues from offshore locations has risen steadily to 43.8 percent, thus optimising cost. This, together with a consistently higher utilisation of over 80 percent, has enabled the company to increase its operating margins.

Attrition in the company, though reducing, is still high at 15 per cent. Any wage hikes to stem this would hamper margins.

HCL's BPO division has returned to profitability at the operational level. Being a low-margin business, it remains to be seen if this will be sustained.

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