FY21/22e EPS down 2/6% to factor in Covid-19 pain; TP cut to Rs 644; valuation’s attractive; ‘Buy’ retained
HCL Technologies (HCLT) delivered another strong quarter vis-à-vis estimates—USD revenues were flat q-o-q while CC revenues were up 0.8% q-o-q; Ebit margin expanded 70bps q-o-q to 20.9%, notably outperforming the estimate of 19.4%. Management abstained from issuing the guidance for FY21 citing uncertainty—in line with other IT players. The company signed 14 large transformation deals, which would enable it to maintain the growth momentum.
We believe the Mode-3 business will face challenges in the near term due to the COVID-19-induced dislocation, but cloud-related acceleration in demand would keep momentum strong. We are trimming FY21/22 estimates by 2%/6% to build in near-term pain and also tweaking down the target multiple from 16x to 15x (the latter in line with our cut for the sector). The stock is attractive at 11.5x FY22e EPS in our view. Maintain Buy with a revised TP of Rs 644 (15x Q2FY22e EPS; Rs 704 earlier) as we roll over the valuation to Q2FY22e EPS.
Mode-2 fires up again, offsetting Mode-1 and -3 weakness
Sequential flat revenue growth in spite of the COVID-19 dislocation is attributable to very strong 7% q-o-q growth in the Mode-2 business that largely offset the weakness in the Mode-1/Mode-3 business, down 0.4%/1% q-o-q. ER&D and Financial Services inched down 1.8% q-o-q and 1.1% q-o-q, respectively, while Technology Services grew a robust 7.2% q-o-q. By vertical, Telecom slid 6.6% q-o-q, whereas Life Sciences rose 2.3% q-o-q.
Robust margin performance, but COVID-19 will inflict pain
HCL Tech, surprisingly, reported margin expansion of 70bps q-o-q to 20.9% in Q4FY20 in spite of the disruption caused by COVID-19. The current pandemic would exert pressure on margins in the near term, and would be followed by a gradual recovery in FY22. We believe management would run a tight ship, thereby maintaining costs and margin that might be further aided by currency tailwinds. Hence, FY21 margins may not erode substantially.
Outlook and valuation: Cloud benefits but virus stings; retain Buy
HCLT has posted robust >10% organic growth in FY20 and is on a strong footing, but COVID-19 will cause short-term volatility. At 11.5x FY22e EPS, the stock is trading at an attractive valuation and a favourable risk-reward. Retain ‘BUY/SP’.