HCL Technologies: Margins disappoint

Even as HCL Technologies raced ahead of peers in terms of constant-currency revenue growth for the December 2015 quarter, the market wasn't excited. Constant-currency revenue growth for HCL Tech stood at 2.1 per cent versus 0.5 per cent to 1.1 per cent for peers such as Tata Consultancy Services (TCS), Infosys and Wipro. Healthy traction in its infrastructure management services (IMS) business (36 per cent of revenues) as well as application services (40 per cent of revenues) was the key revenue driver. The company's rupee revenues grew 2.4 per cent sequentially to Rs 10,341 crore, a bit ahead of Bloomberg consensus estimate of Rs 10,281 crore.

The disappointment was on the profitability front. Though earnings, too, beat estimates, these were aided by margin gains, higher ‘other income’ as well as lower tax rate. While ‘other income’ comprises of non-core unsustainable trading gains, margins, too, were boosted partly by a low base in the September 2015 quarter.

Ebit (earnings before interest and tax) margins were aided by one-time provisions related to disengagement with a client in the September 2015 quarter. Weakness in engineering and R&D (research and development) business (18.6 per cent of revenues), which was down 1.5 per cent sequentially in constant-currency terms, higher costs related to Chennai floods (which the company absorbed) and wage raises also curtailed margins in the December quarter. Overall, Ebit margins grew 60 basis points sequentially to 20 per cent, with tailwinds from rupee depreciation and higher employee utilisation.

Some analysts say margins could have been higher. "Ebit  margin was flat when adjusted for the one-offs in the base quarter, and slightly lower than our expectations", says Harit Shah of HDFC Securities. Analysts expected this metric to be 21 per cent.

Even as net profit grew 11.2 per cent sequentially to Rs 1,920 crore as against an expectation of Rs 1,805 crore, the stock fell five per cent intra-day  before closing 0.3 per cent lower at Rs 840.5.

Anil Chanana, chief financial officer, HCL Technologies, has repeated an Ebit margin target of 21-22 per cent. But analysts are not convinced, given that first-half Ebit margin stood at 19.7 per cent. Chanana also remains confident on the road ahead and is betting big on the rebid market. He believes the company should comfortably match sector growth this financial year. If the targets are achieved, the stock should see gains. But, a valuation re-rating could happen if HCL Tech is able to match its peers, which enjoy Ebit margins of 23-26 per cent.