HCL Technologies Rating: Buy- Growth accelerated in the third quarter

Margins disappointed; no structural issues with core biz any longer; FY22e EPS down c3%; ‘Buy’ retained with target price of Rs 1,530

The company maintained its double-digit earnings growth guidance.
The company maintained its double-digit earnings growth guidance.

HCLT finally surmounted a series of misses: It reported a strong revenue beat for Q3FY22 with revenue growth of 7.6% q-o-q in constant currency terms. Growth was driven by both its R&D and products business (on expected lines), but IT services reported decent 4.7% growth as well. The Ebit margin at 19% was a bit of a let-down, however, especially for the core IT services business, which was down c200bps q-o-q despite strong growth. The company maintained its double-digit earnings growth guidance.

We continue to believe that there are no structural issues with HCLT’s core business and that worries over HCLT’s Infrastructure business cannibalisation are no longer warranted. The transitory loss of market share in the ER&D business also appears to be behind now. The full-year growth guidance for the products business was maintained at 0-1%, which means products are expected to be down c20% q-o-q in Q4FY22. Overall, the demand commentary was positive, deal wins were strong (BBR of 0.7x in Q3FY22) and the pipeline was strong.

Margin guidance for full year FY22 downgraded to a little lower than 19% (18.8-18.9%) from the previous range of 19-21%. While growth has accelerated, profitability has suffered, led by the sharp fall in profitability for the core business (excluding products) for which the Ebit margin was down to 17.0% in Q3FY22 (19.0% including products). According to management, the margin for the core business has been impacted by higher wage inflation and is likely to recover only gradually in the coming quarters. Although the wage inflation impact makes sense, we note that most other peer companies, such as Infosys (INFO IN, Rs 1,896.80, Buy), have been able to recover this cost by improved pyramids.

In our view, this clearly reflects HCLT’s relative weakness to hire, train and deploy campus freshers compared with its peers. HCLT has historically been more reliant on lateral/real-time hiring, and this year’s surge in demand has challenged its campus hiring infrastructure. We believe that as demand and supply stabilise, HCLT will be able to recover some profitability for its core business. The company’s implied guidance for the EBIT margin for Q4FY22 is about 18.5%, which is led by the expected fall in the products margin in Q4FY22.

Retain Buy and TP of Rs 1,530 but lower estimates: Our earnings estimate for FY22e falls by c3% to factor in this quarter’s results and comments.

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