Buy HCL Technologies - Re-rating to continue - IIFL

Given weakness in discretionary service lines and commoditization of traditional IT services, we believe HCL Tech's larger exposure to the infrastructure business will continue to result in one of the best growth rates. Further, its focus on profitability, a weakness hitherto, has mitigated. Its investments in training campuses and increased fresher hiring allow it to rationalise the employee pyramid. In addition, our interactions indicate that as its large deals mature, the company will require relatively less experienced personnel. Despite it EPS Cagr being one of the best in the industry, its valuations are cheap at 12.9x FY13ii PER. Reiterate BUY.

Infrastructure services - the opportunity remains big: Although many areas of IT services have witnessed lacklustre demand, infrastructure services have displayed robust growth. Penetration of offshoring is high in traditional services such as ADM, whereas it is nascent in case of infrastructure services. Moreover, the global market size for infrastructure services is 2.5x that of traditional ADM. HCL Tech has the largest contribution from infrastructure services and we expect it to benefit the most from robust growth here.

Margins can continue to surprise positively: Although profitability has been HCL Tech's weakness, its Ebitda margins have surprised positively over the past two quarters. We believe that after the recent reorganisation, the company's focus on profitability has improved. Its investments in training centres in Manesar and Nagpur enable it to increase fresher ratio and benefit from efficiencies engendered by the age pyramid. Moreover, as its large deals progress, we believe the age profile of the project teams will reduce.

Cheap valuations, despite re-rating: HCL Tech has added many marquee clients over the past three years and it continues to benefit from cross-selling opportunities. It is also inherently better suited to the new demand environment with its greater flexibility in engagement models and a diversified portfolio of offerings. Consequently, valuations have re-rated. However, they are still cheap and at a discount to larger peers.

Source : Equity Bulls

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