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Indiadaily 08Aug19 INDIA DAILY August 8, 2019 India 7-Aug 1-day 1-mo 3-mo Sensex 36,691 (0.8) (5.2) (2.9) Nifty 10,856 (0.8) (6.1) (4.4) Contents Global/Regional indices Dow Jones 26,007 (0.1) (3.0) 0.2 Daily Alerts Nasdaq Composite 7,863 0.4 (2.9) (1.0) Results FTSE 7,199 0.4 (4.6) (1.0) HCL Technologies: Strong revenue growth Nikkei 20,500 (0.1) (4.8) (5.1) Hang Seng 25,997 0.1 (8.2) (10.4) Adani Ports and SEZ: Contained outperformance continues KOSPI 1,917 0.4 (7.1) (11.6) Value traded – India Pidilite Industries: Growth moderates, margin outlook improves further Cash (NSE+BSE) 363 346 356 Mahindra & Mahindra: Cost-cutting actions protect margins Derivatives (NSE) 15,359 10,483 9,818 Deri. open interest 3,427 2,992 3,268 Tata Steel: Weak quarter; margins under pressure: Cipla: Domestic drags performance Forex/money market Change, basis points Siemens: Running into rough weather 7-Aug 1-day 1-mo 3-mo Rs/US$ 71.2 25 256 145 HPCL: Muted results 10yr govt bond, % 6.7 - (22) (88) KEC International: Steady on execution, weak on order inflows Net investment (US$ mn) 6-Aug MTD CYTD (1,157 FIIs (264) 8,247 JK Lakshmi Cement: Record margins led by strong prices ) Results, Change in Reco MFs 407 - 3,408 Top movers – 3mo basis Lemon Tree Hotels: Looking beyond Change, % Sector alerts Best performers 7-Aug 1-day 1-mo 3-mo TGBL IN Equity 269 (0.4) 2.2 35.1 Automobiles & Components: State-wise demand trends in 1QFY20 DABUR IN Equity 431 (0.3) 7.3 17.3 NEST IN Equity 11,777 (0.5) (0.2) 14.4 Banks: Lending rates soften UNSP IN Equity 599 1.1 3.1 13.7 Economy alerts BHARTI IN Equity 366 (0.6) 2.7 12.8 Worst performers Economy: RBI MPC: Growth remains the primary focus IDEA IN Equity 5 (5.3) (53.3) (62.6) RCAPT IN Equity 49 (3.2) (19.7) (57.4) JPA IN Equity 2 (5.9) (11.1) (51.5) NOTIFICATION RELI IN Equity 51 0.8 1.3 (49.1) We are dropping coverage of India Cements (M.cap: US$350 mn, AVD:US$3 mn) on YES IN Equity 87 1.8 (6.8) (46.0) account of diminished investor interest. [email protected] Contact: +91 22 6218 6427 For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES. REFER TO THE END OF THIS MATERIAL. ADD HCL Technologies (HCLT) IT Services AUGUST 07, 2019 RESULT Coverage view: Cautious Strong revenue growth. HCLT reported strong 4.2% qoq c/c revenue growth led by Price (`): 1,023 large deal ramp-up. Margin contracted sharply due to seasonal costs, investments in Fair Value (`): 1,175 IBM products and decline in ERD margins. Broader direction of business has improved BSE-30: 36,691 with balanced growth across offerings and robust growth in engineering services. We have reservations in products business investment but find it adequately priced in. Fair value changes marginally on the back of currency assumptions. Company data and valuation summary HCL Technologies Stock data Forecasts/Valuations 2019 2020E 2021E 52-week range (Rs) (high,low) 1,188-920 EPS (Rs) 73.2 73.0 81.8 Market Cap. (Rs bn) 1,387.0 EPS growth (%) 17.5 (0.4) 12.1 Shareholding pattern (%) P/E (X) 14.0 14.0 12.5 Promoters 60.0 Sales (Rs bn) 604.3 690.6 768.4 FIIs 28.7 Net profits (Rs bn) 100.9 98.4 111.1 MFs 4.5 EBITDA (Rs bn) 139.3 157.7 177.0 Price performance (%) 1M 3M 12M EV/EBITDA (X) 9.4 8.4 7.5 Absolute 0.6 (9.6) 5.6 ROE (%) 25.6 22.1 22.0 Rel. to BSE-30 8.4 (5.7) 8.4 Div. Yield (%) 0.8 3.0 3.2 Xerox and other large deals drive strong 4.2% growth; EBIT margin contracts sharply HCLT reported c/c revenue growth of 4.2% on sequential basis and 17.1% on yoy comparison. Organic revenue growth stood at 3.7% qoq and 14% yoy, much above our estimate. Revenue growth was led by 18% qoq growth in the manufacturing vertical, courtesy Xerox large deal ramp-up. The key driver of revenue outperformance was lower-than-expected ramp-down from a couple of financial services and one manufacturing client. Revenues declined in financial services; HCLT is more vulnerable than peers due to higher contribution from stressed capital market clients. EBIT margin declined 180 bps qoq and 260 bps yoy. The decline was on account of rupee appreciation, large deal transition costs and costs associated with infrastructure creation for consummation of acquired select products of IBM. Net profit of Rs22.2 bn declined 13.6% qoq and 7.6% yoy due to higher-than-expected tax rate and sharp margin contraction. Surprisingly conservative revenue growth guidance HCLT requires flat organic revenue growth in the remaining three quarters to achieve mid-point of the growth guidance. To put it differently, HCLT has guided 14-16% c/c revenue growth (8-10% organic) for FY2020E. Growth in 1QFY20 was 17%, which will accelerate to 18.2% in 2QFY20, after completion of acquisition of select products of IBM. We reckon that part of the caution could be due to potential ramp-down from a large financial service client and a few large deals that have ramped up faster and reached steady state. Large deal wins continue to be strong and will power growth in FY2020E. EBIT margin—sharp decline across segments HCLT has changed segment reporting to IT Services and Business, ERS and Products & Platforms from Applications, IMS and BPO earlier. EBIT margin declined across all key offerings in the Kawaljeet Saluja quarter, a surprise and can be explained by 15 bps headwind from rupee appreciation, 20 bps headwind from higher visa costs, 50 bps impact from investments for consummation of IBM products’ acquisition and 110 bps headwind in ERS segment (detailed later). We note that HCLT Sathishkumar S has been underinvested in core IT services and took remedial measures in the past three quarters. This has led to margin pressure (not a surprise for us) even as it helped improve overall growth profile and has started lending a bit more comfort on sustainability. HCLT has guided 18.5-19.5% EBIT margin for FY2020E, achievable in our view despite a weak start at 17.1% to the year. The company expects margins to be in the guided range from the next quarter. [email protected] Contact: +91 22 6218 6427 For Private Circulation Only. FOR IMPORTANT INFORMATION ABOUT KOTAK SECURITIES’ RATING SYSTEM AND OTHER DISCLOSURES, REFER TO THE END OF THIS MATERIAL. HCL Technologies IT Services Not a perfect company, but a good stock HCLT model does have it challenges. We are disappointed with investments in products business. The company still has some ground to make in digital competencies. On the whole, the stock at 12X FY2021E earnings is extremely attractive and worth an investment. We bake in revised INR/USD assumption of our economist and higher tax rate implications of the IBM acquisition. These result in 3-8% cut in FY2021-22E EPS. Fair value stands at Rs1,175/ share valuing the company at unchanged 14X FY2021E earnings. A large part of the earnings cut can be attributed to increase in tax rate to 24% from 21- 22% earlier. The increase in tax rate is largely non-cash. Essentially HCLT gets an advantage of tax deductibility on amortization of goodwill. However, in corporate books, goodwill is never amortized. This ends up creating permanent difference between company books of accounts and income tax ones. HCLT has created deferred tax liability despite this being a permanent difference. IBM products acquisitions—the balance sheet impact HCLT has paid out US$813 mn of the agreed US$1,775 mn purchase consideration for seven products of IBM. The installment of US$813 mn will be paid out in June 2020. The deal also has an earn-out clause equating to US$150 mn over three installments. The present value of this purchase consideration stands at US$1,736 mn. Five of the seven products that were acquired by HCLT were part of the earlier IPR agreement. Unamortized present value of IPR stood at US$427 mn. The purchase price comprising price paid, fair value of earn-out, remaining consideration and unamortized value of IPR stood at US$2.162 bn. HCLT has allocated US$903 mn to customer relationship that will be amortized in proportion of estimated revenue over a period of 10 years. US$352 mn been allocated to technology/ IP, which will be amortized over a period of 7-10 years based on product life. The company also allocated US$918 mn to goodwill. Despite the payment of the first installment, HCLT is a net cash balance company. Thinking further about the seeming revenue growth and margin trade-off HCLT’s 1QFY20 margin profile had several one-offs and upfront investments. The first reason for weak margin was investments in people, infrastructure, systems and processes to integrate select IBM products acquisition. While the expenses will flow through the P&L for the entire June 2019 quarter, consummation of the acquisition and consequently revenues will start flowing through only from September 2019 quarter. This creates a mismatch and will impact margins by over 50 bps in June 2019 quarter.
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