HCL Technologies - Elevated margin & high growth trajectory to sustain - BRICS

HCL Technologies's (HCLT) net earnings for Q1FY13 came in ahead of our expectation, as the company managed to protect its margin despite wage hikes. HCLT negated the impact of wage hikes using operational levers, like facilities consolidation, improvement in utilization and shift in offshore mix. HCLT's elevated margins are likely to sustain, as it still has headroom left for achieving broader execution excellence. We are raising our FY13/14 earnings estimate by 8.6%/7.6% respectively, after factoring in margin performance, demand visibility from the renewal market, and the Rupee appreciation. Revise target price to Rs690 (from Rs640) and Reiterate BUY.

Q1FY13 results surpass expectations: Revenue grew by 2.9% qoq to Rs60.9bn (up 3.2% qoq to US$1.11bn in US$ terms) and was largely in line with our expectation. The growth came mainly from the Infra business, up 10.4% qoq, and a volume growth of 4.5% qoq. The negative impact of a hike in billable employees' wages (8% for offshore and 2% for onsite) was fully offset by a combination of improvement in utilization (to 79.6% - blended), hike of 1.5pp in offshore mix and consolidation of 8 sites. HCLT will use the same operational levers to reduce the impact of a similar wage hike of its non-billable employees on its margins in Q3

Strong focus on renewal market to help sustain deal momentum: HCLT won 12 new multimillion dollar deals in Q1FY13 by taking advantage of the churn in deal renewals and contracts. HCLT has achieved a deal win rate of 51% due to its narrow focus on the renewal market and selective targeting of clients. The momentum in deal wins is likely to continue, as deals worth US$61bn are up for renewal in H2CY12 (v/s US$41bn in H1). The renewal market is expected to strengthen further over CY13 and CY14, thus providing better demand visibility and opportunities for HCLT. Outlook and valuation: The stock trades at a P/E of 12x FY13 and 10.7x FY14 earnings estimates. Raising target price to Rs690, based on P/E multiple of 13.5x average FY13-14 earnings. Reiterate Buy based on growth visibility from strong order bookings, headroom left for margin improvement and ability to benefit from vendor churn.

Raising earnings estimates due to higher than expected margin: We are raising our FY13/14 US Dollar estimates to account for the stronger than expected performance of Infra services and weaker Software services. We are lowering our Rupee estimates by 3% and 1.3% for FY13 and FY14 respectively, to account for the Rupee appreciation (to Rs53/US$ from the earlier rate of Rs55/US$). HCLT's performance on the margins front could exhibit a cyclical behaviour on a quarterly basis, based on "deal hunting-project delivery" cycle, but is likely to sustain at elevated levels on an annual basis, given the flexibility in the company's operating structure, consolidation of its facilities and operating levers, like employee pyramid, utilization and offshore mix.

Source : Equity Bulls

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