>hcl technologies (ANGEL BROKING)

‘Axed on’ growth'

HCL Technologies’ Axon acquisition, while a long-term positive, is expensive and will lead to Margin and Bottom-line pressures, given lower Margins of Axon, US $585mn debt taken on and goodwill write offs. The slowdown has led to greater uncertainty in HCL's prospects and has started reflecting in its financials. Even as valuations are at historic lows, we see little scope of re-rating, given the headwinds faced by the company and 1.4% EPS compounded fall estimated over FY2008-10E. We Initiate Coverage on the stock with a Reduce recommendation and Target Price of Rs96, implying a P/E of 6x FY2010E EPS.

* Axon, an expensive acquisition: HCL Tech had acquired the UK-based Axon Group plc last year for £441.1mn (US $658mn). While the strategic rationale of the deal is well understood, in the medium-term, owing to lower Margins of Axon, debt of US $585mn taken on and goodwill write-offs, HCL Tech's Margins and Bottom-line are expected to remain under pressure. We expect the Axon deal to become EPS-accretive only post-FY2011.
* Forex losses expected owing to significant hedged positions: HCL Tech had a significant US $1.6bn as outstanding hedged positions at the end of 2QFY2009 (nearly 75% of FY2009E Revenues). In an environment of currency volatility and Rupee depreciation, this subjects the company to significant risks. Accumulated losses in "Other Comprehensive Income" in the Balance Sheet stood at US $210mn. With the Rupee not expected to strengthen anytime soon against the greenback, forex losses are likely to continue to negatively impact Earnings, even as the company is not taking any fresh hedges.
* Valuations low, but little scope for re-rating; high dividend yield provides cushion: HCL Tech's stock has traded in a historical 1-year forward P/E band of 5-21x over the past six years. However, over the past year, with the global economic slowdown and deterioration in prospects of the sector, the stock has been severely de-rated with its trough P/E multiple at just 5x. Thus, at current levels of 6.7x P/E multiple, the stock is trading close to its life-time low levels. However, we do not expect any major re-rating going forward given the weak global economic environment, overhang on account of the Axon acquisition and a disappointing 1.4% EPS compounded de-growth estimated over FY2008-10E. However, a dividend yield of 8.4% provides some downside cushion.

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