HCL Technologies: Buy

Among top-tier IT companies, HCL Technologies (HCL) has consistently been a leading player in terms of growth rates over the past few years.

The company’s key financials have expanded at a rate that is among the best in the industry, generally in line with TCS and ahead of large vendors such as Infosys and Wipro.

Growth in all its key verticals, healthy client additions and improvements in important operational parameters that have helped margin expansion are key positives for the company.

In this light, investors with a two-year perspective can buy the shares of HCL.

At Rs 680, the share trades at 12 times its likely per share earnings for FY14, which is at a discount to TCS and Infosys, making it a reasonable entry point. Given the stock’s rally in recent months, investors can also consider accumulating the share on any weakness linked to the broader markets.

In the first half of this fiscal, HCL’s revenues grew 24.8 per cent over the same period in FY12 to Rs 12,364.8 crore, while net profits rose nearly 73 per cent to Rs 1,849.5 crore.

Broad-based growth

Over the past couple of years, HCL has witnessed industry-leading growth in volumes and largely stable pricing. This has ensured steady revenue growth much ahead of most top-tier offshore software vendors.

Large verticals such as financial services (25.8 per cent of revenues), healthcare (11.9 per cent) and retail (9 per cent) have all grown at a pace that has been faster than the overall company’s revenue rate. Manufacturing (27.2 per cent) too has grown, though at a slower pace.

With most of its segments delivering, the expansion for HCL has been quite broad-based.

In terms of its offering, infrastructure services (in which HCL is a top player) have seen maximum traction. Though other service offerings too have grown, they have lagged behind.

Sustained deal momentum

In the last one year, the number of clients in the $100 million-plus category has risen from three to five currently.

Addition of customers in the $20-50 million bucket has increased by 17, while there has been one more client added in the $50 million-plus category.

Clearly, the outsourcing momentum continues to be favourable for HCL.

In terms of operational parameters, the company has done well on multiple factors to improve revenues as well as shore up margins.

Over the last one year, the company has increased the proportion of projects worked on from offshore locations quite significantly. As a result, 74.2 per cent of the efforts happen from low-cost locations, an increase of 1.7 percentage points over the past one year. This improved effort-mix reduces costs.

Utilisation too has increased over the past one year and stands at 81.9 per cent, which is among the highest in the industry. In many ways, this figure reflects the kind of traction in terms of rising volumes (man months billed) that the company is witnessing. In terms of types of projects executed too, the shift has been towards those that are margin-enhancing.

So, fixed price contracts that ensure better realisations than time and material projects have witnessed an increase of over 5 percentage points in terms of their contribution to revenues to 51.4 per cent currently.

The proportion of revenues spent on direct costs (largely wages paid) and selling and marketing have been reduced and a tight leash maintained on expenditure.

The BPO services division, which was loss-making, has turned around and become profitable at the EBIT (earnings before interest and taxes) level for HCL.

All these factors have had a cascading division with both operating (EBITDA) and net margins, both improving by more than 4 percentage points over the last one year.

Pricing pressure, especially in large deals, can erode margins for the company and is a key risk.

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