Stock Update HCL Technologies
Reco: Buy
PT: Rs950
CMP: Rs800
Below expectations; maintain Buy with PT revised to Rs950 Key points - Revenues slower than expected: For Q3FY2016, HCL Technologies (HCL Tech) has reported a weaker-than-expected revenue growth of 1.3% QoQ at $1,587.2 million on a reported basis and 1.7% Q-o-Q growth on a constant-currency (CC) basis (weaker growth rate on lower base as compared with Infosys [1.9%] and TCS [2.1%]). The lower-than-expected revenue growth was attributed to some project closures in the BFSI space and some slow ramp-ups. The IMS services grew by 3.9% QoQ (in line with our expectation), IT services grew by 0.7% QoQ, while BPO declined by 4.1% QoQ on a CC basis.
- Margins fall short of estimates: Despite the absence of Chennai flood cost and rupee tailwinds, the EBIT margins for Q3FY2016 fell short of expectations. Importantly, the management has stopped providing margins guidance for FY2017, owing to integration margins headwinds from Volvo (Q1FY2017) and Geometric Ltd (end of FY2017). The net income for the quarter remained flat at Rs1,926 crore as compared with Rs1,920 crore (includes property sale of $21 million) in Q2FY2016.
- Deal wins remain strong, but conversion remains weak: Deals won for the quarter remained strong with seven transformational deals worth in excess of $2 billion in total contract value (TCV), twice as compared with the usual $1 billon TCV. Effectively, the total number of transformational engagements during the nine month of FY2016 stood at 25, with a TCV of more than $4 billion. Looking at the revenue CQGR of 0.9% in the last six preceding quarters, deal conversions look weak, as some of the deals have a longer execution cycle time, which is affecting the deals conversion. The management has indicated at strong deals pipeline, though seeing short of big ticket deals in the engineering and R&D services verticals, while the financial service space remains soft due to vendor consolidation, digitisation, automation and shift in the outsourcing model.
- Maintain Buy with a revised price target of Rs950: The increasing complexity deals engagement (slower deal conversion) and integration of headwinds will result in volatile earnings performance in FY2017. Further, lack of conviction in management commentary on the organic growth front, ex Volvo in Q1FY2017 and absence of margins guidance, will affect the near-term stock's performance. We have revised our estimates down for FY2017 and FY2018 by 7% and 2% respectively. We expect, after near-term hiccups and volatility, margins performance will start showing improvement with deals reaching steady state (also reflects in revenue growth), which will be the most important re-rating trigger for HCL Tech. The stock is trading at inexpensive valuation of 14x and 12x its FY2017E and FY2018E earnings. We have maintained our Buy rating on the stock with a revised price target of Rs950.
Bharti Airtel
Reco: Hold
PT: Rs425
CMP: Rs372
Robust performance; maintain Hold with price target revised to Rs425 Key points - Q4FY2016 result snapshot; strong performance, operating profit jumps 8.1% QoQ: Bharti Airtel (Bharti) posted a strong show, with consolidated operating profit growth of 8.1% QoQ, led by a strong 3.6% Q-o-Q growth in the revenue. The solid voice volume (+6% QoQ) and data volume (+9.6% QoQ) aided the top-line growth, while margins across the segments were on the expansionary mode, with Indian mobile margins at 39.9% ). Low tax for the quarter negated the effect of higher interest and depreciation cost, resulting in a 15.5% Q-o-Q growth in earnings. Adjusting for exceptionals, the net earnings grew by 4% QoQ.
- Management comments: The management in the conference call mentioned that a strong voice volume growth in the quarter is the result of sharper and aggressive portfolio segregation and go-to market initiative drive, coupled with its greater emphasis on the network quality. It continued to maintain that the current level of voice prices (at 33.25 paise per minute) is not sustainable and is likely to increase in the medium to long run, but the competitive intensity continues to drive it low. On the upcoming spectrum, it continued its stance of higher base price of 700-Mhz band, but mentioned that it would be interested in the 2,100-Mhz band. On Africa, its strategy of concentrating on data growth and making itself sustainable has started yielding some results. For FY2017 it guided for a capex of overall $3.1 billion.Further the company has also announced its buyback plan for Rs1,434 crore at a price of Rs400, that it would receive from its subsidiary Bharti Infratel (Bharti Infratel has announced buyback of Rs2,000 crore at the price of Rs400).
- Outlook & view: Bharti's robust performance (industry-leading volume growth and margins), along with improving Africa trajectory validate our thesis of improving execution from Bharti. Further, after the recent spectrum deals with Videocon and Aircel, Bharti has enhanced its pool of both 3G and 4G spectrums, making it less vulnerable to the competitive intensity in the upcoming auction. Thus, Bharti continues to be our preferred pick in the sector, but the impending risk in the form of the launch of Reliance Jio and uncertainty over its pricing and market strategy makes us retain our Hold rating on the stock. In this note, we have introduced our FY2018 estimates, while maintaining our FY2017 EBITDA estimates. We expect Bharti to post 9.9% and 10.6% revenue and EBITDA CAGR, respectively, over FY2016-18E. With the forward rolling of the multiple to FY2018, our price target stands revised at Rs425 (valued at 6.2x its FY2018E EV/EBITDA).
Gateway Distriparks
Reco: Hold
PT: Rs315
CMP: Rs284
Weak demand environment affects margins and earnings; downgrade to Hold Key points - Weak macro environment and margin pressure continue to affect earnings: For Q4FY2016, Gateway Distriparks Ltd (GDL)'s consolidated adjusted earnings after minority interest and associate income declined by 45.7% YoY to Rs26.5 crore. The consolidated revenues were affected by lower volumes in container freight station (CFS; down 6.6% YoY) and rail (down 14.6% YoY) divisions. The volume off-take was primarily affected by lower and imbalanced export-import trade, loss in volumes at Punjab conware and Chandra facilities, rise in competitive intensity at Vizag and no major benefit from double stack cost savings. Subsequently, the company witnessed over 700-BPS erosion in operating profit margin (OPM) for both CFS and rail divisions. Consequently, the operating profit for the quarter declined by 37.0% YoY to Rs49.0 crore.
- Near-term uncertainty to remain: In the near term, the outlook for a revival in the CFS and rail divisions seems difficult which is likely to affect the financials of the company for H1FY2017. The management has lowered growth guidance for rail volume for FY2017 to single digit (albeit on a low base). However, the Krishnapatnam CFS facility is expected to start operations during the current year while Viramgam inland container depot (ICD) is expected to start to contribute meaningfully from Q3FY2017 onwards. These measures to revive CFS volume and to save 2-4% of rail haulage charges are yet a year away to materially affect the earnings positively.
- Downgrade to Hold with revised price target of Rs315: We believe, the headwinds in the company's CFS and rail divisions are expected to continue in the near term, affecting its financials. The improvement in trade environment and revival in operating profit margin (OPM) in its businesses will be the key monitorable going ahead. Although the structural growth story over the long term remains intact for GDL (owing to a range of services, leadership position in the CFS and rail businesses, and a healthy balance sheet), the near-term uncertainties is likely to weigh heavy on valuation. Consequently, we have downgraded the stock to Hold with a revised price target of Rs315.
- Risk: The risk to our call is earlier-than-expected revival in demand environment coupled with improvement in OPM.
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