HCL Technologies

HCL Technologies - Reader’s Digest’s deal part of Q3 deal win.

HCL Technologies (HCL Tech) has announced that it has signed an information technology (IT) outsourcing engagement worth over US$350 million with Reader’s Digest Association spread over seven years. Though HCL Tech won record deals of US$1 billion in Q3FY2009, the company is likely to incur an upfront transaction cost of US$25 million for clients. Hence, there is a risk to the company’s earnings, as the upfront transition cost on some of the new deals may not be supported by increased volume from the clients in the current difficult environment.

Further, the rupee has depreciated significantly, close to 5.2%, in the last one month and is expected to remain weak in coming days. The depreciation in the rupee is likely to again expand HCL Tech’s unrecognised foreign exchange (forex) losses. In Q3FY2009, the company’s unrecognised forex losses expanded to US$207 million from US$156 million due to the depreciation in the rupee.

At the current market price, the stock is trading at 5.5x FY2009 earnings estimate and 5.8x FY2010 earnings estimate. Historically, HCL Tech has traded on an average of 20-25% discount to Infosys. However, the stock has de-rated in the last six to nine months and the discount has widened to 53% due to HCL Tech’s aggressive hedging policy causing huge pile of forex losses on its balance sheet and due to acquisition of Axon in the current difficult environment. Given the huge pileup of unrecognised forex losses and the risk to the company’s earnings due to upfront transition cost and the dilution of margin from Axon’s acquisition, once cannot see any re-rating in HCL Tech’s price/earning (PE) multiple in the near term. Hence, based on the earnings estimates the price target works out to Rs145.