HCL Technologies Ltd reported a decent 2.3% growth in revenue in constant currency terms for the September quarter, on the back of a 2.7% growth in volumes. But the worry is that growth continues to be driven by one segment—infrastructure management services (IMS), which grew by 13% quarter-on-quarter in constant currency terms.
Business process outsourcing remained weak, falling by 2.4% and 3.1% in the past two quarters. The software services unit was more or less flat in constant currency terms.
IMS has been driving growth for the company for the past few quarters, thanks to large deals won earlier this year. In the June quarter, the IMS segment grew 21.3% in constant currency terms. But dependence on one service offering has it own risks.
The enterprise application services segment, which accounts for more than one-fifth of the company’s revenue, reported a 5% drop in revenue last quarter in constant currency terms, on the back of a 0.7% drop in the June quarter. This segment reflects the performance of Axon Group Plc, and some analysts are worried about the outcome of the large acquisition made about a year ago. To be fair to the company, enterprise application services have been weak for the whole industry. Having said that, the weakness in this segment causes one to wonder about the timing of the acquisition and the relatively high price paid for it.
While HCL Technologies managed to improve margins, it was through a sharp reduction in selling, general and administrative (SG&A) expenses. Its peers, meanwhile, have been able to generate savings even in direct costs by managing employee expenses aggressively. One view is that the cut in SG&A may be harmful in the long term, given the company’s reliance on new order wins for growth. HCL Technologies gets a much larger proportion of its business from new clients. According to the company, though, SG&A costs are lower because of efficiencies in general and administrative costs, and sales investments have been maintained.
In sum, the results are unimpressive when stripped of the growth in IMS. What’s more, cash flow generation has been particularly weak. Free cash flow stood at a mere $10.2 million (around Rs48 crore), compared with a cash profit (net profit plus depreciation) of $96 million. It’s no wonder the company’s shares fell 2% on Wednesday, even though shares of peers rose marginally. The fact that the company’s valuations are already at a considerable discount to top-tier technology firms may, however, protect the downside to some extent.
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