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Tuesday, August 25, 2009

HCL Technologies:Sharekhan upgrades the price target

HCL Technologies
Cluster: Apple Green
Recommendation: Hold
Price target: Rs343
Current market price: Rs307

Price target revised to Rs343

Result highlights

HCL Technologies (HCL Tech)? Q4FY2009 results were above our as well as street expectations led by better-than-expected operating performance and lower-than-expected foreign exchange (forex) losses. The unrecognised forex losses also reduced sharply during the quarter. However, the sharp fall in deal flow, possibility of slower ramp-up on one large deal from Readers Digest Association (RDA; due to its troubled financial condition) and free transition cost given in some of the deals in the last few quarters (that may impact its margins) remain the concerning points.
The consolidated revenues for the quarter grew by 1.6% sequentially to Rs2,908.5 crore. In dollar terms, the revenues grew by 7.6% sequentially to US$607.2 million due to favourable cross-currency movement (3.7%). In constant currency terms, the revenues grew by 3.9% sequentially driven by volume growth (2.7%). The realisation declined marginally by 0.4% sequentially during the quarter.
The the earnings before interest and tax (EBIT) margin improved by 164 basis points to 22.1% in Q4FY2009. The improvement in the EBIT margin was on account of higher number of working days (70 basis points) and efficiency gains (146 basis points). This was however partially offset by unfavourable currency movement (52 basis points).
The net income grew by 51.4% sequentially to Rs330.1 crore, above our expectation of Rs224 crore. The result came significantly above our expectation due to better-than-expected operating performance and lower-than-expected forex losses. The company reported forex losses of Rs88.6 crore in Q4FY2009 v/s Rs201.6 crore in Q3FY2009. The effective tax rate was higher at 22% in Q4FY2009 due to one-time provision of US$6.6 million for clarification on Section 10AA in the recent budget. The company has conservatively provided for this impact, as it mentioned that the full exemption of profit from special economic zone (SEZ) units is likely to be provided on prospective basis and not on retrospective basis.
HCL Tech?s hedge position has reduced to US$813 million in the quarter under review from US$1288 million in the previous quarter. The unrecognised forex losses sitting on the balance sheet have also fell sharply to US$161 million in the quarter from US$225 million in the previous quarter. While the higher forex losses are likely to keep its earnings under pressure in FY2010, HCL Tech should see sharp increase in FY2011 earnings due to absence of significant portion of forex losses.
HCL Tech?s management remained cautiously optimistic on the demand environment. The company has seen sharp fall in deal flow in this quarter compared to two quarters ago. The management indicated that the company would to be able to execute the projects aggregating US$460 million from the large deals (~U$2.5 billion) won in FY2008 and FY2009. This provides revenue visibility for only 20% of FY2010 revenues. The fall in deal flow may hinder its top line growth going forward.
Recently RDA, from whom HCL Tech bagged one long-term deal (worth US$350 million) in March 2009, has filed for chapter 11 bankruptcy for restructuring its debt. While HCL Tech mentioned that the development would not impact RDA?s engagement with HCL Tech as informed by RDA, we believe this may delay the execution of deal from RDA?s end due to its difficult financial condition.
We have fine-tuned our earning estimates upward to reflect better operating performance as well as to incorporate sharp reduction in unrecognised forex losses. Consequently, we have revised upward our FY2010 earnings estimate to Rs16.5 per share and our FY2011 earnings estimate to Rs22.9 per share. The sharp growth in FY2011 earnings would be largely driven by absence of significant portion of forex losses.
Overall, HCL Tech reported better-than-expected results in Q4FY2009. The unrecognised forex losses sitting on the balance sheet also reduced sharply during the quarter. However, the softness in the deal flow, ramp-up on the RDA deal and free transition given on few deals that could dilute its margins remain the few concerning data points. Furthermore, the stock has run up sharply by 74% in the last three months, leaving limited upside at the current level. Hence, we maintain our Hold recommendation on the stock with a revised price target of Rs343. At the current market price, the stock is trading at 18.6x FY2010 earnings estimate and 13.4x FY2011 earnings estimate.

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