Strong deal wins drive optimism
* HCL Tech’s qoq growth of 2.7% in CC terms was largely in line with our expectation of 3.0% qoq growth. However, higher than expected cross-currency headwind (190bps vs 100bps expectations) led to a lower than expected USD growth of 0.8% in Q1FY19.
* EBIT margin improvement of 10bps qoq to 19.7% was slightly lower than our expectation of 40bps qoq improvement but ahead of street estimates of 19.3%.
* Management turned incrementally optimistic on organic growth prospects as it signed its best ever deal-wins during the quarter. Expect traction for IMS segment to improve H2FY19 onwards as new deals ramp-up. Retained revenue/OPM guidance on CC basis.
* Record deal signings, improved client mining, increased insight on IP investments (mix, status and outlook), retention of guidance and buoyant management commentary on organic growth outlook would drive earnings/rating upgrades. We now assign BUY rating to HCL Tech with TP of Rs1,200 valued at 16x FY20e earnings.
Robust deal wins, better outlook/insights on IMS/IP investments
With 27 new transformational deals (broad based - includes strategic $0.5bn+ deal from Nokia in Next-gen-Infra-management), HCL highlighted that deal bookings in Q1FY19 have been the highest in its history which will help it deliver strong growth in the long term. For FY19, HCL Tech maintained its CC revenue growth and guidance of 9.5-11.5% as it expects benefits to revenues from these new deals to start flowing towards FY19 end and FY20 start (average lag of 4 months). On IMS, management attributed slower than expected ramp-up in new deals and impact of soft renewals and structural reductions to the modest Q1FY19 performance, however expect the segment to deliver strong growth from Q3FY19 given expected ramp-up in recent deal wins and robust pipeline. HCL Tech also highlighted that there are three to four large deals in its pipeline which, if converted, can lead to significant growth outperformance. HCL Tech re-iterated its margin guidance of 19.5-20.5% as it intends to direct some of the INR depreciation benefits towards digital investments (Innovation centers) and expects increase in costs as new deals ramp-up.
Confident commentary to drive earnings/sentiments across; Upgrade to BUY
HCL Tech commentary turned significantly optimistic as it expect the organic growth momentum to accelerate going forward given highest ever deal bookings recorded in Q1FY19. HCL also shared greater insights into metrics and commentary in the IP investments that would boost financial estimates as well as sentiments from these investments. Our sector Outperformer view on the stock got further reinforced post the Q1 commentary and believe that positive commentary would result in earnings upgrade and eventual re-rating of the stock. We upgrade HCL Tech to BUY with TP of Rs1200 valued at 16x FY20e earnings.
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