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 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).
HCL Tech’s hedge position has reduced to $813 million in the quarter under review from $1288 million in the previous quarter.
The unrecognised forex losses sitting on the balance sheet have also fell sharply to $161 million in the quarter from $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.
We have fine-tuned our earnings 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.