Weak show in September quarter may take a toll on HCL Technologies' valuations

The stock of HCL Technologies has fallen over 13 per cent in just three trading sessions to Tuesday after the company announced last week that its sales and operating margin are under pressure due to cross-currency fluctuations and project issues with one of its clients.

For investors who were so far gung-ho about the company's prospects, what it means is that the operating margin would stray from the company's preferred margin band for the second consecutive quarter and that the stock valuation may suffer in the short term.


The firm has a preference band of 21-23 per cent for the operating margin ( EBIT margin). In the June 2015 quarter, its margin fell sequentially by 110 basis points to 20.2 per cent, thus deviating from the target band for the first time in two years. The management at the time had stated higher investment in onshore staff and activities as a major reason for shrinking margin.

For the September 2015 quarter, the first quarter of the company's fiscal, investors may face more margin contraction on two factors: unfavourable movement of euro and pound and $20 million provision to account for a possible loss of business in case of one of its unsatisfied clients.

During the September quarter, major European currencies including the euro and the pound depreciated against the dollar. HCL Tech earns nearly one-third of revenue from Europe. When the company converts this revenue into the dollars for reporting purpose, realisations would drop. This is known as cross currency impact.In addition, it may have to report actual hedging loss if any, which will arise if the average quarterly rupee-dollar rate is more than the contract rate at the time of hedging the future receivables.

These factors may pull down the firm's dollar denominated revenue growth for the September 2015 quarter. While the exact magnitude of impact would be hard to estimate, it may be half or even lesser than analysts' earlier estimation of 3-3.5 per cent sequential growth. It means short-term deterioration in the stock valuation cannot be ruled out. Over the past four years, its trailing price-earnings (PE) ratio peaked at over 22 from the lows of 14. After last week's announcement and subsequent stock fall, its PE is 16.5.

This may suffer a further drop if its September quarter is poor. This is because, historically, the quarter had reported good growth for Indian IT exporters against December and March quarters, which are usually slack periods. A poor September quarter, hence, means a possibility of depressed growth for the remaining year.