Recommendation: Buy
CMP: Rs 305
Price target: Rs 365
Key points:
· HCL Technologies has transformed itself from a marginal IT player to a well differentiated, full services player focused on large deals. This would sustain dollar based revenue growth at a CAGR of 32% over the next few years. However, with the twin challenges of an appreciating rupee and the phasing out of the STP tax holiday under sections 10A and 10B in FY10, earnings growth would decline.
· In the third phase of its transformation, the company plans to re-define its business model to reduce the linearity between manpower expansion and revenue growth and this should dampen the decline in EPS. I initiate coverage on the company with a Performer rating.
· Aggressive strategy to de-link manpower expansion and revenue growth: Business models in the IT services industry have predominantly borne a direct correlation between manpower growth and revenue growth. HCL plans to reduce this correlation by using innovative pricing models (device based pricing, outcome-based pricing, pricing per user, etc).
· The company already has a number of engagements based on these models. While peers also plan to de-link man power growth and revenue growth, I believe HCL with a smaller base and a well outlined strategy is at the forefront of this change.
· Impact of appreciating rupee to be minimal: HCL has forward covers for the next eight quarters to the tune of $1.73 billion at an average rate of Rs 43.15 to a dollar. The hedges cover 90% of the net forex inflows for around six quarters. We believe this is among the most well hedged companies in the IT space.
· I maintain Buy recommendation on this stock with a time frame of 12 months.
