10 January 2014

HCL Technologies - Infrastructure Svcs led-growth not at cost of balance sheet -Centrum

Rating: Buy; Target Price: Rs1,540; CMP: Rs1,246; Upside: 24%



Infrastructure Svcs led-growth not at cost of balance sheet

In response to investor concerns about HCLT’s balance sheet
deterioration as revenue share of Infra. Svcs increases, we note that
though 67.3% of FY13 incremental revenue came from Infra. Svcs, this
has not affected the balance sheet as HCLT’s deals are not based on
the now-obsolete asset-takeover models that the erstwhile EDS (now
part of HP) was known for. We believe that HCLT’s current P/E discount
to its Tier-1 peers is undeserved and maintain Buy with an unchanged
Dec’14 TP of Rs1,540 (noting that possible re-rating can provide
further upside)..

$ Fixed asset turnover improvement despite Infra Svcs led growth =>
asset light deals: Fixed Assets turnover has actually improved for
HCLT from FY09 to FY13 (see table on page 1 in the report and Exhibit
1) even as Infra. Svs proportion of revenue has nearly doubled. While
it still lags industry leaders like TCS and Infosys in terms of Fixed
Asset turnover due to the Axon acquisition that had added INR33.5Bn to
Goodwill in FY09, it leads these peers when excluding Goodwill.
Translation exchange differences relating to the goodwill added a
further INR8.4Bn to HCLT’s goodwill over FY12.

$ DSOs incl. Unbilled Rev. similar to TCS and Infosys; part of FP
contract models: At 90.4 days, HCLT’s FY13 DSOs including unbilled
revenues is comparable to Infosys’ 86.6 days and TCS’ 99.9 days for
their respective FY13 (see Exhibit 1). We think that an increase in
DSOs is bound to happen with a shift to fixed price execution that is
milestone-based as milestones for large programs may not be easy to
invoice monthly and an increase in unbilled revenue becomes
unavoidable under these circumstances.

$ EBITDA to OCF conversion ex-working capital similar across HCLT,
Infosys, TCS: We’ve heard concerns about vendor credit helping boost
OCF for HCLT. We note that working capital contribution to OCF has
been negative every year across FY09-FY13. While vendor credit has
helped HCLT reduce the gap between OCF before and after working
capital changes to a level not matched by Infosys and TCS, we point
out that even excluding working capital changes, HCLT edges out
Infosys and TCS narrowly in EBITDA-to-OCF conversion.

$ Maintaining estimates; maintain Buy: HCLT is currently trading at a
steep discount of 18% to Infosys and 27% to TCS in P/E terms. We
maintain our estimates and maintain our Buy recommendation with an
unchanged Dec’14 TP of Rs1,540 (14x 1-Year Fwd EPS at Dec’14 Our
target PE still factors an 18% discount to our target multiple of 17x
for TCS and if investor perception regarding Infra. Svcs improves, a
rerating can provide further upside. The recent resumption in
outperformance could thus continue. Key risks to our call are 1) a dip
in win-rates for large Infrastructure Svcs deals and 2) sharp INR
appreciation.

Thanks & Regards

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