HCL Tech (Q1 F6/13)

CMP Rs581, Target Rs650, Upside 11.8%

• Infra services shine but slower s/w services growth dampens performance

• Broad based growth across verticals/geographies; BFSI growth stands out

• OPM performance ahead of estimates on the back of strong operational efficiencies 

• Soft quarter impacted by slower discretionary spending; Continue to be positive on long term strategy; Maintain BUY

Infra services shine but slower s/w services growth dampens performance

HCL Tech’s consolidated dollar revenues registered a 3.1% sequential growth lower than our expectation of 4%. While the consolidated volume growth was 4.5% qoq, the increased offshore component (-1.1% impact) led to the lower dollar revenues. Infrastructure services grew stronger-than-anticipated at 10.4% qoq in dollar terms. On the flip side, the slower growth in software services (0.5% qoq in dollar terms) was both due to lower volume growth (+2.5% qoq versus expectation of 4%) and correction of ~1.9% in realisation due to higher offshoring. Management indicated that lower discretionary spending have impacted growth of these services. Deal wins were good with HCLT registering twelve deal wins across verticals.

Broad based growth across verticals/geographies; BFSI growth stands out

The growth for Q1 F6/13 was largely broad based across verticals and geographies. Amongst key verticals, BFSI grew impressively at 4.4% qoq in dollar terms. Emerging verticals of Life sciences, Retail showed strong growth 14.6%/10.6% qoq in dollar terms. On the flip-side, Hi Tech manufacturing (28% of revenues) was flat qoq. Discretionary services of EAS as well as Engineering services grew at a slow pace (-1.3%/0.4% qoq respectively).  Infrastructure services, on the other hand, continued its strong streak growing 10.6% qoq and boosting the overall performance of the company. Due to increased focus and recent deal wins, US and Europe grew well at 3.9%/2.8% qoq growth in dollar terms.

Top clients showed weakness post two quarters of strong growth. Top5/10 clients grew 1.9%/2.3% qoq - slower than company average of 3.1% qoq growth.

OPM performance ahead of estimates on the back of strong operational efficiencies

Consolidated operating margin for Q1 F6/13 outperformed our expectation by expanding 20bps (against estimate of 160bps correction). This margin beat was on the back of efficiency & utilization gain of 72 bps (due to ramp up/offshoring recently won deals), G&A leverage benefit of 18bps and lower than anticipated wage hike impact. Higher than expected margin and in-line OI resulted in PAT coming ahead of estimates at Rs8.64bn. Going forward, residual salary hikes and increased front-end investments to chase deals in re-bid market are expected to be key margin headwinds .On the flip side, various operational levers like utilization, offshoring and employee pyramid are expected to be key levers to support the OPM. On the employee front, net additions were tepid at 1.2% of Q4 F6/12 base. Attrition on an LTM basis reduced marginally to 13.6% (versus 14% earlier).

Soft quarter impacted by slower discretionary spending; Continue to be positive on long term strategy; Maintain BUY

Q1 F6/13 performance was soft versus street expectation considering the slower dollar revenue growth registered by the company. This weakness was largely due to lack of discretionary spending –an industry wide issue. Barring the software services’ tepid performance, both Infrastructure services business as well as BPO grew impressively driven largely by the ramp ups of the deals garnered in Q2-Q3 F6/12. In the current year too, large deals coming up or re-bidding in the next two quarters (~ US$61bn in value) could possibly help garner similar wins for the company facilitating further revenue visibility. Post incorporation of Q1 F6/13 results, we expect HCLT to register 11.8%/15.5% dollar revenue/rupee earnings CAGR over F6/12-14E. We recommend BUY with a 9-month TP of Rs650.