HCL Technologies: Mixed Bag

HCL Technologies (NS:HCLT): We maintain ADD on HCL Tech (HCLT IN), which posted in-line revenue but lower margins in Q1, while maintaining the FY23E revenue guidance (12-14% CC) and moderation within the unchanged margin band (lower-end of 18-20%). Key positives included (1) strong growth in ERS and growth ahead supported by two large ERS deals (both in the ISV segment); (2) positive commentary on the deal pipeline (near an all-time high) and net new bookings tracking higher (23% YoY) with TCV at USD2bn providing growth visibility; and (3) availability of margin levers supporting expansion from Q1 base – pricing, sub-contracting rationalisation (impacted by new region expansion), fresher/pyramid and utilisation (we maintain estimates below the target EBITM band). The weaker elements included a softer sequential trajectory in services (albeit the base impact of ~5% CQGR over the last three quarters) as well as a higher impact on IT & BS services margin (partial impact of Q1 seasonality + higher sub-con expenses).

HCLT’s strong credentials in ER&D services, Mode-2 driving IT & BS growth, cross-sell of services into the P&P customer base, and integrated/vendor consolidation deals are expected to be drivers. Our TP is INR 1,125, based on 19x FY24E EPS, supported by ~5% FCF & dividend yield; stock trades at 18x and 16x FY23/24E.

HCL Technologies

Mixed bag

We maintain ADD on HCL Tech (HCLT IN), which posted in-line revenue but lower margins in Q1, while maintaining the FY23E revenue guidance (12-14% CC) and moderation within the unchanged margin band (lower-end of 18-20%). Key positives included (1) strong growth in ERS and growth ahead supported by two large ERS deals (both in the ISV segment); (2) positive commentary on the deal pipeline (near an all-time high) and net new bookings tracking higher (23% YoY) with TCV at USD2bn providing growth visibility; and (3) availability of margin levers supporting expansion from Q1 base – pricing, sub-contracting rationalisation (impacted by new region expansion), fresher/pyramid and utilisation (we maintain estimates below the target EBITM band). The weaker elements included a softer sequential trajectory in services (albeit the base impact of ~5% CQGR over the last three quarters) as well as a higher impact on IT & BS services margin (partial impact of Q1 seasonality + higher sub-con expenses). HCLT’s strong credentials in ER&D services, Mode-2 driving IT & BS growth, cross-sell of services into the P&P customer base, and integrated/vendor consolidation deals are expected to be drivers. Our TP is INR 1,125, based on 19x FY24E EPS, supported by ~5% FCF & dividend yield; stock trades at 18x and 16x FY23/24E.

Q1FY23 highlights: (1) HCLT revenue came in line with our estimate at USD 3,025mn, +2.7/+15.6% QoQ/YoY CC. (2) Total services revenue grew 2.3% QoQ CC, led by ER&D growth of 3.7% QoQ CC, followed by IT & BS growth of 2% QoQ CC. P&P revenue witnessed a healthy growth of 5.1% QoQ CC. (3) HCLT booked a net-new TCV of USD 2.05bn (+23.4% YoY), which included seven large services deals and nine product deals in the quarter. (4) Within verticals, growth was led by technology & services (+10.9% QoQ CC) and telecom & media (+4.3% QoQ CC). (5) EBITM at 17% (below our estimate of 17.7%), -100bps QoQ, was impacted by the decline in services margin on account of higher sub-con, retention, and travel cost. (6) Net additions were at 2,089 in Q1, taking the headcount to 210k, supported by 6k fresher added in Q1FY23. The management intends to add 10k fresher in Q2 and around 35k fresher for FY23E.

Outlook: We assume a USD revenue CAGR of 10.5% and an EPS CAGR of 9% over FY22-24E, with IT&BS CAGR of 10.9%, ER&D CAGR of 13.9%, and a P&P CAGR of 2.6%. We factor in EBITM at 17.7/18.3% for FY23/24E. HCLT is trading at 18/16x FY23/24E earnings and a ~34% discount to TCS (NS:TCS) valuation.

Click on the PDF to read the full report: