The Hindu Business Line : HCL Infosystems: Buy

Investments with a one-two year horizon can be considered in the HCL Infosystems stock, considering its strong position in the domestic IT infrastructure market and reasonable valuations. At Rs 272, the stock trades at 14 times its estimated 2007-08 earnings.

This is at a discount to competitors such as CMC, partly explained by the low earnings before tax, depreciation and amortisation (EBITDA) margins (about 4 per cent) that HCL Info enjoys. But considering its integrated operations across the IT hardware segment, strong deal wins and reasonable growth expected from the relatively new forays, margins could improve.

The company is in the entire gamut of IT infrastructure offerings such as desktops, laptops, servers, storage solutions, security, and networking solutions. This integrated operation helps the company cater to a wide range of clientele.

Business Drivers

Computer sales holds promise: The company has its own brand of desktops and laptops. Over the last three-four years, HCL Info has managed to expand rapidly and capture an IDC-estimated market share of 15.5 per cent in the desktop and 7.4 per cent in the laptop segments in the Indian market.

Compared to other MNC players in these segments, HCL Info’s pricing is fairly aggressive and may position it to capture further market share, considering that PC penetration is very low in India. Several governmental agencies have heightened spend on computing devices, presenting a potential market.

As the cost of hardware components that are imported to assemble desktops and laptops reduces, the company may be able to further bring down costs, expand margins or, alternatively, play the volume game. A substantial increase in the relatively high-margin laptop sales may also help margins.

Nokia GSM phone sale rights: The company had rights to distribute Nokia’s GSM phones through HCL Info’s channel and retail stores.

Nokia’s position among the top mobile handset players in India helped the company in terms of revenue growth. But this contract has been re-negotiated in 2006 and HCL Info will be transferring 50 per cent of the country-wide distribution area to be handed back to Nokia by this year-end. The transition period has seen a blip on the revenue front. But with GSM phone sales expanding at a rapid pace, growth may continue at a reasonable pace once the transition-related issues are sorted out.

Increased focus on system integration: The company seems to have increased its focus on the high-margin system integration projects. Recent deal wins such as that with BSNL for convergent billing and setting up data centres, the setting up of VoIP network for Defence through BSNL, valued at over Rs 500 crore each, reiterate this point.

This apart, HCL Info has strong client relationships with PSU banks, e-governance agencies, and the power segment. All these segments are likely to witness increased IT spends in the domestic context, which the company is well-positioned to tap.

In addition, media and entertainment sectors have also been added to the portfolio. This includes a presence in the high-growth FM station business, where it provides radio design and implementation services. TV broadcasting is another area where the company has won a deal.

These apart, new forays have been made into segments such as railways, airports, retail, healthcare — all of which have growth potential.

Other new forays: The company has obtained rights to sell a wide range of gadgets and digital equipment through its retail outlets. These include the highly successful iphone, Kodak’s digital cameras, Toshiba’s laptops and the rights to sell Dish TV packages as well.

These offerings, though at a nascent stage, are expected to gain momentum in the near future. The company has also forayed into the training business with a focus on hardware. With a wide-ranging product experience, this new venture of HCL Info can be watched for sustainable revenues.

Risks: The company may face stiff competition from players such as CMC, Datacraft and Wipro Infotech, which may create margin pressures. The company’s operations are import-intensive as it imports products for reselling. Any depreciation in the rupee, after the significant appreciation in recent quarters, is a risk to margins.

As the reliance on government clientele increases, which is a strong possibility, the receivables cycle may be longer, thus increasing working-capital requirements.

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