HCL Technologies - Infrastructure Svcs led-growth not at cost of balance sheet - Centrum

In response to investor concerns about HCLT's balance sheet deterioration as revenue share of Infra. Svcs increases, we note that though 67.3% of FY13 incremental revenue came from Infra. Svcs, this has not affected the balance sheet as HCLT's deals are not based on the now-obsolete asset-takeover models that the erstwhile EDS (now part of HP) was known for. We believe that HCLT's current P/E discount to its Tier-1 peers is undeserved and maintain Buy with an unchanged Dec'14 TP of Rs1,540 (noting that possible re-rating can provide further upside).

Fixed asset turnover improvement despite Infra Svcs led growth => asset light deals: Fixed Assets turnover has actually improved for HCLT from FY09 to FY13 (see table below and Exhibit 1) even as Infra. Svs proportion of revenue has nearly doubled. While it still lags industry leaders like TCS and Infosys in terms of Fixed Asset turnover due to the Axon acquisition that had added INR33.5Bn to Goodwill in FY09, it leads these peers when excluding Goodwill. Translation exchange differences relating to the goodwill added a further INR8.4Bn to HCLT's goodwill over FY12.

DSOs incl. Unbilled Rev. similar to TCS and Infosys; part of FP contract models: At 90.4 days, HCLT's FY13 DSOs including unbilled revenues is comparable to Infosys' 86.6 days and TCS' 99.9 days for their respective FY13 (see Exhibit 1). We think that an increase in DSOs is bound to happen with a shift to fixed price execution that is milestone-based as milestones for large programs may not be easy to invoice monthly and an increase in unbilled revenue becomes unavoidable under these circumstances.

EBITDA to OCF conversion ex-working capital similar across HCLT, Infosys, TCS: We've heard concerns about vendor credit helping boost OCF for HCLT. We note that working capital contribution to OCF has been negative every year across FY09-FY13. While vendor credit has helped HCLT reduce the gap between OCF before and after working capital changes to a level not matched by Infosys and TCS, we point out that even excluding working capital changes, HCLT edges out Infosys and TCS narrowly in EBITDA-to-OCF conversion.

Maintaining estimates; maintain Buy: HCLT is currently trading at a steep discount of 18% to Infosys and 27% to TCS in P/E terms. We maintain our estimates and maintain our Buy recommendation with an unchanged Dec'14 TP of Rs1,540 (14x 1-Year Fwd EPS at Dec'14 Our target PE still factors an 18% discount to our target multiple of 17x for TCS and if investor perception regarding Infra. Svcs improves, a rerating can provide further upside. The recent resumption in outperformance could thus continue. Key risks to our call are 1) a dip in win-rates for large Infrastructure Svcs deals and 2) sharp INR appreciation.

Source : Equity Bulls

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