HCL Technologies rating: Buy; a brisk start to the new fiscal

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Updated: August 17, 2019 3:07:24 AM

Management has maintained FY20 revenue growth guidance of 14–16% (cc), out of which 6% is expected to be inorganic.

Aggressive amortisation of intangible assets remains an overhang, but the stock is attractively priced at 13.4x FY20e EPS in our view.Aggressive amortisation of intangible assets remains an overhang, but the stock is attractively priced at 13.4x FY20e EPS in our view.

HCL Technologies (HCLT) kicked off FY20 with revenue (up 17% y-o-y in constant currency, 3.8% q-o-q in USD terms) beating expectations (decline of 1.9%) and operating margin undershooting at 17.1% (versus 18.1% estimate).

Management has maintained FY20 revenue growth guidance of 14–16% (cc), out of which 6% is expected to be inorganic. Operating margin guidance of 18.5–19.5% was preserved too. While commentary on deal-wins is positive, we believe organic growth would be front-ended in H1FY20 and the bulk of growth in the second half would be inorganic. Aggressive amortisation of intangible assets remains an overhang, but the stock is attractively priced at 13.4x FY20e EPS in our view. Maintain Buy with a revised TP of Rs 1,360 as we roll over the valuation to Q3FY21e EPS (16x Q3FY21e EPS, Rs 1,300 earlier).

Strong revenue outperformance
The strong 17% y-o-y (cc) growth is largely driven by the faster-than-expected ramp-up of a deal-win in the manufacturing vertical. As revenues from its acquisition of IBM IP begin to show up from Q2FY20, the contribution of inorganic revenue will creep up in H2FY20. We believe the company is on track to meet its revenue growth guidance of 14–16% (cc).

Investments mildly strain margins
Operating margin dipped by 190bps q-o-q driven by seasonal factors such as visa costs and currency headwinds. While we expect the company to meet its operating margin guidance, investments to build up digital capabilities and SG&A pertaining to IBM IP may hold back margin expansion.

Outlook: Attractively priced
We believe HCL’s acquisitions in IP as well as capabilities in digital will enable it to deliver industry-leading organic growth. The stock’s current valuation of 13.4x FY20e EPS also implies limited downside and a favourable risk-reward. Hence, we maintain ‘BUY/SP’.

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