HCL Technologies (HCL Tech) has announced that it has signed an information technology (IT) outsourcing engagement worth over $350 million with Reader’s Digest Association spread over seven years.
Our interaction with the management leads us to believe that this deal is a part of $1 billion worth of deals the company had won in Q3FY2009.
Though the company won record deals of $1 billion in Q3FY2009, we highlight that the company is likely to incur an upfront transaction cost of $25 million for clients.
Hence, we see risk to the company’s earnings, as the upfront transition cost on some of the new deals may not be supported by increased volume from the clients in the current difficult environment.
Further, the rupee has depreciated significantly, close to 5.2%, in the last one month and is expected to remain weak in coming days.
In our view, the depreciation in the rupee is likely to again expand HCL Tech’s unrecognised foreign exchange (forex) losses.
In Q3FY2009, the company’s unrecognised forex losses expanded to $207 million from $156 million due to the depreciation in the rupee.
Outlook and valuation
At the current market price, the stock is trading at 5.5x FY2009 earnings estimate and 5.8x FY2010 earnings estimate. Historically, HCL Tech has traded on an average of 20-25% discount to Infosys.
However, the stock has de-rated in the last six to nine months and the discount has widened to 53% due to HCL Tech’s aggressive hedging policy causing huge pile of forex losses on its balance sheet and due to acquisition of Axon in the current difficult environment.
Given the huge pileup of unrecognised forex losses and the risk to the company’s earnings due to upfront transition cost and the dilution of margin from Axon’s acquisition, we do not see any re-rating in HCL Tech’s price/earning (PE) multiple in the near term.
We maintain our HOLD recommendation on the stock with a price target of Rs144.