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Spark Capital - HCL Tech 1QFY14 result review: Strong performance continues; Retain ADD




Spark Capital Advisors(India) Private Limited


28 Oct 2013





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Strong performance continues; Retain ADD HCL Tech (HCLT) posted 1QFY14 results with inline revenues and strong beat on the margins. US$ revenue growth of 3.5% qoq was led by Infra (8.7% qoq) while Application services continue to remain soft (0.9% qoq). The surprise was on EBITDA margins, which improved 280 bps qoq led by currency gains. From Sep-11 to Sep-13 HCLT has expanded margins by 900 bps and we believe rupee depreciating by ~35%. HCLT has been passing through the currency gains into margins. We are surprised by Management’s comfort in non investment of rupee gains. We expect margins would decline to FY13 levels as HCLT increases its front end investments. Improving macro environment, strong order book and superior positioning in RIM would position HCLT to deliver inline with industry growth. At CMP, HCLT looks very attractive (trading at FY15E PE of 8.8x and EV/EBITDA of 8.8x) led the recent price correction (10%) after the 1QFY14 results. Retain ADD with increased TP of 1210, arrived by attaching 14x to our Sept-15 EPS. Steady revenue performance: 1QFY14 revenues grew 3.6% qoq in CC led by Infra Services (up 8.8% qoq in CC) while core software was weak (1.1%). Across geography, US led growth (4% qoq) while Europe came in at 1% qoq and ROW came in at 8.5% qoq. We are concerned by the high contribution of RIM in HCLT growth. On a TTM basis RIM accounts for 75% of incremental US$ revenues. In FY14E Infrastructure services would continue to show high growth whereas Software services is expected to be a laggard. Across verticals, Manufacturing, healthcare and Financial service is expected to led growth whereas Telecom could continue to be sluggish. HCLT won more than US$ 1 bn worth of TCVs this quarter, including nine transformational deals. Margins beat of 168 bps: HCLT’s EBIT margin came at 23.8% increased 276 bps qoq mainly led by rupee gains. HCLT has the second highest EBIT margin after TCS. From Sep-11 to Sep-13 HCLT has expanded margins by 900 bps and we believe rupee depreciating by ~35%. We believe margins would peak out at this level as HCLT would direct more of these rupee gains into front end investments like peers. Retain ADD: We believe that on the back of strong order book, HCL Tech would continue on its strong growth trajectory in FY14E and FY15E as well. We are modeling US$ revenue growth of 13% and 14% for the same. Further, we believe margins would reach an historical high of 22.4% for FY14E.Additionally, at CMP, HCLT looks very attractive led the strong price correction (10%) after the 1QFY14 results. Retain ADD with increased Target price of Rs.1210.

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