Why HCL Tech, TCS could not impress markets in Q2

When expectations are high, even the slightest miss can be disappointing.

The September quarter performance of at least three of India's top-five information technology (IT) services companies indicates that.

After missing the market estimates on the revenue front by a whisker, Tata Consultancy Services (TCS), in recent times the darling of the stock market, was punished by investors on Friday.

So with HCL Technologies, which delivered numbers below expectations. While Infosys' numbers were ahead of expectations, TCS and HCL Technologies', steady performers in recent years, could not impress the Street on many counts.

HCL Technologies, which announced its numbers on Friday, reported a 32 per cent rise in the net profit at Rs 1,873 crore or Rs 18.73 billion.

However, the net profit grew 2.1 per cent sequentially, much below market expectations.

The revenues at Rs 8,735 crore or Rs 87.45 billion) saw a 10 per cent year-on-year growth and a 3.7 per cent sequential expansion.

Another negative surprise in HCL's numbers was the decline in the margin by 40 basis points to 21.4 per cent.

The company attributed it to the currency fluctuations and higher expenses on account of wage rise.

"HCL's results were below estimates. Revenues disappointed with a constant currency growth of 3.2 per cent. Ebitda (earnings before interest, depreciation, taxes, and amortisation) margins also came in slightly below expectations," said Dipen Shah, head (private client group research) at Kotak Securities.

"The constant currency growth has moderated in the past few quarters and overall revenue growth has come in largely on IMS (infrastructure management services).

The company needs to improve growth rates in non-IMS businesses," he said in a note.

For the quarter, while Infosys has been able to perform largely in line with the expectations, TCS fell short of consensus revenue estimates by $20-25 million, which the management attributed to continued softness in the insurance vertical and slower-than-expected ramp-ups in the retail vertical.

However, its sequential revenue growth of 7.7 per cent was much higher compared to Infosys' 4.5 per cent and HCL's 3.7 per cent. TCS' revenues came on the back of strong volume growth (increase in the number of man-hours billed) of 6.1 per cent.

These were three per cent for Infosys and 3.2 per cent for HCL.

TCS also indicated that with the miss in the second-quarter revenues, the company would no longer be able to meet the earlier forecast of exceeding the FY14 revenue growth of 16.2 per cent in FY15.

In terms of net profit, Infosys reported healthy growth, indicating its focus on productivity-enhancement drives as well as cost optimisation (taken by N R Narayana Murthy when he had returned to the Bangalore-based company last year) was paying dividends.

However, while both Infosys and TCS managed to expand their operating profit margins despite wage rises and currency headwinds, HCL Technologies, steadily improving its margins, saw a decline.

In terms of client addition, TCS and Infosys added far more clients. While Infosys added 49 clients, including six large deals, TCS announced eight large contracts whereas the client addition during the quarter was 43. HCL Technologies added 15 large deals at $1 billion.

The client additions included one in the $100-million-plus category and four in the $50-million-plus one.

Surendra Goyal and Rishi Iyer of Citi Research in their report 'Indian IT services take a breather: Positives priced in?' said the general improvement in the macroeconomic environment was not translating to revenue acceleration for IT services.

This could be due to the commoditisation in some traditional IT service lines.

The most disappointing metrics in the case of Infosys was the further increase in its employee attrition, which peaked 20.1 per cent in the September quarter, while TCS and HCL have largely managed to contain it.

During the quarter, the attrition at HCL Technologies was 16 per cent, which the company said was largely stable. "TCS' performance was not bad per se, though it was softer than expectations.

I would say inflated expectations of the Street (18-19 per cent growth in FY15) look unachievable and that's why the number has been downgraded.

Looking at Infosys, there were limited expectations and it fared well ahead of those," said Shashi Bhushan, senior research analyst, institutional equities, Prabhudas Lilladher.

"But the extent of negative surprises in HCL Technologies is far stronger than the other two." HCL Technologies President and Chief Executive Anant Gupta termed the performance last year good, given revenues grew 3.2 per cent on a "constant currency" basis.

"The performance has been strong though there have been significant currency headwinds." Gupta said HCL was not witnessing any softness in demand.

But since the company is now catering more to large deals that are more complex, "the time frame of translation of deals from booking to billing is taking longer," he added.

In terms of geographies, HCL Technologies saw its America business grow 5.7 per cent, Europe expand 2.7 per cent, sequentially. The rest of the world declined 6.4 per cent.