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Overweight rating on HCL, target R570

HCL Technologies reported revenues of $1.08 billion, better than peers ? Infosys -0.4%, TCS 4.2% and Wipro 0.3%.

HCL Technologies reported revenues of $1.08 billion (+4.6% q-o-q in constant currency), better than peers ? Infosys -0.4%, TCS 4.2% and Wipro 0.3%.

A margin expansion of 360 bps in the quarter was particularly noteworthy. While the rupee depreciation and no wage increase were the key margin drivers, it still fared better than other companies in the sector.

The company?s client mining has improved in the recent quarters as top clients continue to grow faster than the company. The company currently has five clients with more than $100 million in annual revenues compared to only one such client in Q1FY12.

Long-term business model is intact, but the stock may warrant patience in the near term. HCL is clearly benefiting from its strategy of targeting the restructured deal business and, thereby, a marketshare-led growth.

These are mostly integrated deals and lower in profitability than the usual T&M ADM business, in our view, but much more strategic in nature.

As suggested by the outsourcing advisors TPI, we believe that the number of restructured deals will increase 20% in 2012. This would mean further opportunity for HCL Tech to gain market share and continue its above sector growth trajectory. We expect margins to fall 50 bps y-o-y in FY13 and expect HCL Tech to see top-line led earnings growth. Positively, consensus margin expectations have also come down in the past few months and are currently in line with our forecasts, lowering the risk of disappointment.

We have revised our FY14 earnings estimates by c11%, largely as we factor in margin expansion, led by rupee weakness. In line with rest of the sector, we are reducing our target valuation multiple for HCL Tech as well to 12x (from 14x) to factor in the risk of continued macro slowdown and also a structural step-down in the growth rate of the sector. This is now at a c15% discount to Infosys, from the c30% historic average.

The discount could go down further if HCL Tech maintains its better operational performance over Infosys. We maintain an overweight rating with a target price of R570. We are 4% below consensus estimate for FY14.

HSBC

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First published on: 27-07-2012 at 01:53 IST
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