HCLI's 2QFY11 sales were robust in PCs (+14% yoy) and Office Automation (+50% yoy), but subdued in Telecom (-14% yoy). Its EBIT margin should continue to improve (+27bp yoy in 2Q) led by SI execution, upscaling of new ventures and the sale of loss-making Infinet. We believe the risk of a dividend cut is receding.

2QFY11 results: yoy improvement in top line and EBIT margin
Consolidated revenues were up 2.8% yoy (5.3% qoq) to Rs31.1bn (1.4% above our estimate), driven by a 43.3% yoy uptick in the PC business to Rs10.0bn (RBS est Rs9.0bn), with Telecom/Office Automation down 9.7% yoy to Rs21.0bn (RBS est Rs21.5bn). The EBIT margin (ex-FX) was up 26bp yoy (59bp qoq) to 2.5% (RBS est 2.2%), due to a better mix and improved margin in PCs. FX gains were Rs34m (vs Rs65m in 2QFY10), while the tax rate was up 114bp yoy to 29.2%, resulting in yoy flat PAT of Rs560m (RBSe Rs493m ex-FX).

Most businesses should start delivering, but telecom remains a cause for concern
Revenue growth in the core PC business of 14.0% was heartening, given the recent market share slide. In our view, 50% yoy growth in Office Automation signals a strong demand pickup, but the base effect should catch up in 3Q. We believe Handset Distribution (-14.2% yoy) remains the key worry. A positive surprise came from the Learning business, with annualised revenues reaching Rs1bn, though we think some of this growth was driven by bulk orders.

More conservative on SI execution and Nokia, but new businesses to partly offset this
We turn more cautious on System Integration (SI) execution, as revenue growth continues to lag order inflow (4.1x book/bill ratio). The failure of Nokia's dual-sim phone should impact market share in the near term, but we expect stable volumes supported by other launches.Our forecasts factor in upscaling of Learning and the acquisition of 20% of TechMart, Nokia's Middle East and Africa distributor. Net-net, we cut FY11F revenues 0.4% and FY12F 3.5%.

Earnings downgraded but the risk of an absolute dividend cut seems to be reducing
We cut our EPS by 17% for both FY11F and FY12F, factoring in a likely margin decline in 1HFY11, due to sizeable investments in new businesses and Consumer PC business losses, and our cautious view on SI execution (FY11F/12F revenue forecasts cut by 15%/22% ). The dividend payout looks set to fall from 78% in 2QFY11 (92% in 1Q), raising the potential to sustain its absolute dividend. Buy maintained, with a DCF-based TP of Rs120 (from Rs141).