Buy HCL Tech with target price of Rs 1,025

HCL Tech’s (HCLT) Q3FY15 ebit margin decline of 260 bps q-o-q to 21.6% was a key miss…

HCL Tech’s (HCLT) Q3FY15 ebit margin decline of 260 bps q-o-q to 21.6% was a key miss, compared to our estimate of 100bp decline. While HCLT had cited 21-22% targetted ebit margin band over the past few quarters, repeated outperformance to the band created uncertainty on the pace of margin decline. With accelerated investments during the quarter, margin levels now stand reset to a new normal, in our view.

Soft Americas dragged revenue. Constant currency revenue growth of 2.7% QoQ was below our estimate of 3.9%, dragged by Americas, in retail vertical client and enterprise SI segment. Lower revenue and margin miss drove PAT at R1,680 crore (-12% q-o-q), below our estimate of R1,810 crore, despite a higher other income at R179 billion, versus estimate of R119 crore.

Our dollar revenue estimates for FY16e/17e are cut 2.7%/3.4% on the back of Q3 miss and additional cross currency headwinds; despite maintaining 3.3% CQGR going forward. We cut our FY16e ebit margin estimate by 100 bps as ebit attained 21-22% band – driving 6.6%/4.4% cut in our EPS estimates.

We believe that the margins have been reset to their normal levels for the foreseeable future, and focus will now shift to the company’s performance on revenue growth. We expect it to post dollar revenue CAGR of 12.7% over FY15-17E and EPS at a CAGR of 12.6% too during this period. Our target price of R1,025 discounts FY17e EPS by 16x.

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