HCL Infosystems

Investors can retain their holding in HCL Infosystems, keeping a two-three-year horizon, in light of the company’s ability to tap into domestic IT hardware market, especially from the government and banking sectors.

At Rs 115, the stock trades at nine times its likely 2008-09 per share earnings, which is about the levels which its peer CMC is trading at despite the fact that the latter enjoys much higher profit margins. HCL’s EBITDA margin stands at 4 per cent as against the 22 per cent margins enjoyed by CMC.

The HCL stock, however, gave a dividend yield of nearly 5 per cent at its current market price. Hardware, especially personal computers, shipments have gone down significantly in October-December 2008 for most players across the world and may take a few quarters to pick up. Penetration levels in PC, telecom and office automation products in India, are still very low in India and hence the demand is likely to be much higher compared to western geographies.

Given that HCL Infosystems continues to make inroads in most e-governance initiatives and win substantially large deals (in the range of Rs 500 crore), its intact leadership in desktop PC sales in India and improved contribution to revenues from high-margin services component augur well for revenue visibility and margin expansion. These apart, the company’s partnership with Nokia (leader in domestic mobile handsets) for handset distribution, which now includes selling Nokia’s value added services, may provide volume growth given that mobile subscriber addition is still robust.

In the recent March quarter, HCL saw its revenues grow by a marginal 0.5 per cent to Rs 2,996.2 crore over the same period in 2008. But in terms of segmental revenues, its computer systems and products division has witnessed a 5 per cent growth in revenues over this period. But revenues from its telecom products and office automation division, which predominantly involves reselling of hardware has witnessed a marginal decline.
Computing products and solutions shine

HCL continues to be among the top three players in the Indian computer sales (desktops and laptops) business. It enjoys a combined market share of 9.6 per cent in computer sales and shares the top slot with HP in desktop sales with a 10.6 per cent market share, according to a recent IDC report. Given that laptop sales are increasing and the fact that HCL has tied up with Microsoft to provide low-cost laptops (which enjoys higher margin), there is scope for profit margin growth.

According to IDC, the domestic IT Hardware market in 2009 is expected to grow by 7.1 per cent over 2008 to Rs 63,703 crore. This is likely to be driven by government spending on IT enablement across various ministries, e-governance initiatives and spending by verticals such as banks, power, railways and the like. HCL Infosystems with existing relationship is likely to gain substantially from catering to these segments.

Recent large deal executions for various segment such as the railways for ticket-vending kiosks, BSNL for convergent billing and the Airforce for building VoIP network, Himachal State Electricity Board for billing solutions, meter reading etc, a government of India project executed in Africa are testimony to the fact HCL has a wide-ranging capabilities across sectors. Most of these deals are over Rs 100 crore; some of them are very large in the Rs 500-crore category.

In the private sector, the company has deal wins from several banks and insurance companies and media and entertainment companies (including broadcasting) which are end-to-end in nature and provide long-term revenue visibility.

The repeat order scenario also looks favourable to HCL. These include orders from the railways, banks, insurance companies, state electricity boards and media companies. HCL has also won a deal to automate judiciary operations across the country.

In all these cases, given the transaction intensive nature of businesses, HCL may benefit from updates and upgrades that may be required periodically.

Another interesting development over the last one year has been the thrust on system integration based deals that involve substantial service components and enjoys relatively higher margins. In the recent March quarter, services revenues were up by 48 per cent over 2008 and stood at Rs 193 crore.

Finally, with the re-election of the UPA government, e-governance initiatives may continue at a faster clip, which gives HCL an edge in furthering its relationships,
Telecom products to drive volume growth

HCL’s distribution of Nokia handsets albeit within a smaller geography may rake in volume led growth for the company. The fact that telecom operators continue to add around 8-9 million subscribers every month, further amplified over the last four-five months after Reliance Communications’ GSM foray, may bode well for the company as Nokia enjoys market leadership in the mobile handset space.

The relationship between Nokia and HCL is set to strengthen further with the formation of a JV that would be engaged in selling value added services for mobile customers.

The company sells a whole host of ‘digital lifestyle’ products of global brands such as Apple, Ericsson, Kodak, Microsoft, and Toshiba.

Recently, it has tied up with Cisco Linksys, for distributing networking products. Although hardware sales around the world may slow down, in India, this may not be as pronounced, given that IT and hardware enablement is still nascent.
Risks:

Competition in government deals, especially from Wipro Infotech which has won a large number of such orders, is a factor to watch out for. CMC which has shifted focus from pure hardware sales to system integration deals may offer price competition.

via BL