ICICI Securities report on HCL Technologies:

HCL Technologies sustained its outperforming trend with another quarter of high revenue growth of 9.2% QoQ to USD 395.7 million (i-SEC estimates: USD389.5mn) in Q4FY07. Also, HCL Tech surpassed our as well as street expectations registering 46.7% QoQ growth in PAT (before ESOP charges) to Rs 4.87 billion (i-SEC estimates: Rs 3.86 billion) largely driven by higher forex gain of Rs 2.5 billion (i-SEC estimates: Rs 1.61 billion). HCL Tech registered 170bps QoQ EBITDA margin decline, lower than our estimate of 200bps QoQ. The outstanding Q4FY07 performance was driven by growth across verticals, geographies and service lines (excluding Enterprise Application Services, which registered 0.7% decline in US dollar terms).

The company has been consistently winning more of multi-service large deals, with Q4FY07 witnessing seven new deal wins. Overall, we reiterate our positive outlook on HCL Tech on the back of a total integrated services portfolio with leverage on the global delivery model, resulting in higher wallet share with clients and robust client mining. At the current market price, based on our earlier EPS (after ESOP charges) estimates (before Q4FY07 results), HCL Tech is trading at FY08E and FY09E P/E of 17.6x and 14.5x respectively, which is lower than Satyam’s FY08E P/E of 18.8x, despite traction across service lines in HCL Tech’s diversified business. We reiterate BUY.

Seven large multi-service deal wins across verticals in Q4FY07

HCL Tech has announced seven multi-service, multi-year, multi-million dollar deal wins across verticals, reassuring our belief of being a promising contender for total IT outsourcing with traction across service lines (refer our report on the technology sector: ‘Still a dazzler’, dated July 09, ’07). Table 1 indicates details of the deals bagged in Q4FY07, as per our interaction with the company.

Further, we believe that HCL Tech has bagged a multi-year, multi-million dollar dealfrom another big client in aero space, in competition with leading global and Indian IT vendors. We feel that within IT services also, HCL Tech is demonstrating its capability of winning deals across services lines (including high domain-driven complex services as well as niche IT services such as Engineering Design and R&D), verticals and geographies, further assuring us of improving predictability of revenues for HCL Tech going forward.

Conservative management expectations

With consistent large deal wins QoQ, we believe that management expectation of 30% US dollar revenue growth for FY08 is conservative. We estimate US dollar revenue growth of >35% in FY08E on the back of high growth service line IMS, IT services through total IT outsourcing deal wins and improved client mining. We believe the company would surpass expectations based on its guidance of gross addition of 25,000 employees in FY08E (similar to FY07 gross addition where US dollar revenue growth was as high as 42.4%) and expectations of increase in Non-Effort based revenues, which would contribute 35-40% in FY10 from current insignificant contribution.

EBITDA performance higher than i-SEC estimates; hedging cover further increased

HCL Tech registered EBITDA of Rs 3.5 billion versus i-SEC estimates of Rs 3.4 billion. Margin decline was lower than expected at 170bps QoQ versus our estimate of 200bps, largely due to 120bps higher SG&A as well as rupee appreciation. However, the management has indicated that margin decline through rupee appreciation is fully compensated by high forex gain (Rs 2.5 billion versus Rs 0.42 billion in Q3FY07).

The company has USD 1.16 billion worth of hedging cover as on June 30, ’07 (increased from USD 900 million as at end Q3FY07), which has increased till date. As a result, HCL Tech is now covered for the next six quarters on net forex inflows. The management is mulling to address the rupee appreciation by increasing hedging cover without compromising on investment in SG&A and operations for future growth.