HCL Technologies : BUY

Back-to-Back Strong Quarters Led by Volumes

HCL Tech reported another quarter of EBITDA improvement (despite one-offs from the Tsunami in Japan) led by robust volume growth, higher utilization rates and a strong market share gain / execution in BFSI. Lower DSO days (down by 4 days QoQ) & curtailment of peak BPO losses are added positives. HCL Tech declared consol. rev of Rs 41.4 bn (~6% QoQ & ~35% YoY), EBITDA of Rs 7.2 bn (~13% QoQ & ~18% YoY), & PAT of Rs 4.7 bn (~17% QoQ & ~36% YoY) in Q3FY11.

Key highlights

• Sales: Software svcs grew 6% QoQ. Revenues from IMS grew 9% QoQ and that from BPO rose 1% QoQ.  Blended volume growth was 4.8% with currency contributing ~1% to drive  5.8% QoQ growth in USD terms. Pricing was stable for the quarter.
• EBITDA: Led by SG&A efficiency & reduced losses in BPO segment.
• PAT: Operating profit offset the impact of higher tax outgo. Market share gains/efficient client mining drove operating performance: This quarter saw a blend of client additions and client mining with: (1) closure of 11 large transformational deals; & (2) healthy upgrades esp. across key client buckets of USD 5 / 10 / 20 / 30 mn. HCL Tech showcased strength across key verticals (BFSI, Mfg, E&U* & Public Sector with aggregate rev share of ~61%) and service offerings (Enterprise Apps, IMS & Custom Apps with aggregate rev share at ~77%).
• While rev momentum is strong, we believe following operating levers would offset headwinds from lateral hiring, currency fluctuations and salary hikes: (1) lower BPO losses – mgmt guided for a reduction in peak qtrly BPO losses from USD 7 mn earlier to USD 6 mn; (2) utilization rates at ~76% in Q3FY11 (ample headroom given peak levels of ~79%); and (3) offshore revenue transition.

Valuations

We have revised our FY12E EPS est. upwards by ~6% & now assign a higher PE of 18x (vs. 17x earlier) and rate the stock as a BUY. CAGR btw FY11-FY13E at topline / EBITDA /PAT levels remains strong at 23% / 25% / 27% resp. We have revised our Target Price upwards to Rs 594 (14% upside from CMP).