HCL Technologies Rating: But for products biz, an excellent quarter

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October 19, 2021 1:30 AM

HCLT: The stock is inexpensive and trades at a sharp discount to peers

HCLT resultsHCLT reported sequential revenue growth of 2.6% (3.5% in c/c) to $2.79 bn, lower than our expectations of 5.4% growth in c/c

HCLT results had everything an investor could ask for—strong order wins, stable supply side, record hiring, excellent client metrics, good growth in services and a much-needed enhanced payout policy. Yet results reinforced what we already knew—that products would underwhelm. A new payout policy will dim the lure of outsized acquisitions. We look at the sunny side and believe that the stage is set for growth. Retain Add; FV unchanged.

Products hogs limelight for wrong reasons: HCLT reported sequential revenue growth of 2.6% (3.5% in c/c) to $2.79 bn, lower than our expectations of 5.4% growth in c/c. The miss was due to the products business which declined by 8% due to delays/misses in new licence sales. IT services and ERD grew at a healthy 5.2% and 5.4%. Ebit margin declined 60 bps to 19%, a 80-bps miss relative to our expectations and entirely attributable to products. Impact from the wage hike and higher hiring and subcon costs were offset by Q1’s one-off Covid-related costs. Net profit increased 1.5% qoq and 3.9% y-o-y to `32.6 bn, 3.6% lower than our expectations. Cash conversion is healthy with CFO at 106% of net profit.


Guidance retained: Growth guidance of 10%+ and Ebit margin guidance of 19-21% is unchanged. We forecast 11.3% organic c/c growth and 19.4% Ebit margin in FY2022. HCLT will be a laggard in revenue growth in FY2022e. HCLT has invested significantly in its application capabilities (the primary growth driver) and has improved its positioning in digital transformation spending. Its leadership in engineering will help it gain a fair share in digital engineering. Overall performance has been undermined by woes in the products business, leakage in revenues (such as in-sourcing in Q1FY22 etc.) and Covid-related supply issues. The latter two are manageable while the former is cause for concern.

Cut EPS estimates by 2-4%: Our 2-4% EPS cut is products-related and accounts for 8% Fair Value in our SOTP. Our valuation multiples are largely unchanged. We value the services business at 25X Sep 2023 NOPAT and products business at 7X Sep 2023 Ebitda leading to SoTP-based Fair Value of `1,400. We expect HCLT to close the gap in the growth rate with peers in FY2023 even while the products business constrains overall growth. HCLT can sustain double-digit growth in the services business. The stock is inexpensive and trades at a sharp discount to peers.

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