HCL Infosystems - Opportunity in scepticism

A lull in consumer demand and a 17% fall in the rupee in the last six months pose near-term challenges. However, SI order booking is ahead of our expectations and the recent stock price correction provides an attractive entry point, in our view. 

Near-term pain in the core PC business 

Recent industry data shows PC shipments slowed to single-digit yoy growth in the June 08 quarter, as rising inflation and high interest rates hit consumer demand. Rupee depreciation also put a significant burden on margins, while competition in the commercial PC segment has weakened pricing power. However, some of this impact could be mitigated by down-trading from notebooks to desktops, given HCLI's traditional strength in the latter segment. We reduce our EBITDA margin estimate for the segment by 136bp for FY09 to factor in the rupee depreciation. 

SI order wins are a bright spot, execution is now the key 

HCLI announced cumulative System Integration (SI) order booking of Rs1.2bn for April-August 08. These order wins replenished the current order book, which was substantially executable over FY09. Execution is still the key, given the lumpiness of project revenues. We expect new orders to drive 27% growth in SI revenues in FY09, though we expect revenues to remain volatile on a quarterly basis. 

Reselling business stable, rupee depreciation could mitigate ASP decline 

GSM subscriber additions trended up in the past 12 months, taking account of monthly volatility. We expect current momentum in subscriber additions to be sustained in the medium term, with the likely entry of 4-6 new/crossover players in several circles. The depreciation of the rupee over the last three months could help mitigate the decline in ASPs in the near term. However, we could see some near-term pressure on the segment's margins, given the high margin office automation business depends on corporate capital expenditure levels. 

Valuations look attractive, we expect dividends to be sustained 

We cut our FY09-11F EPS by 20-24% on the back of the slowdown in the PC business and rupee depreciation. We expect near-term financial performance to be slowed by these headwinds. Nevertheless, at 5.6x FY09F EPS, valuations appear attractive both historically and relative to peer group. Our base and stress cases indicate adequate room to sustain the present dividend payout in FY09, implying a 7.7% yield. Buy with a DCF-based target price of Rs157 (down from Rs266).