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Published on 7/10/2019 10:38:20 AM | Source: ICICI Securities Ltd

Buy HCL Technologies Ltd For The Target Rs.1,215 - ICICI Securities

Strength in fundamentals to sustain

We met Mr. Prateek Aggarwal, CFO at HCL Technologies (HCLT) to get an update on the business. HCLT continues to be positive on the demand environment with spends strong across verticals barring two client specific instances, one each in the BFSI and manufacturing verticals. Company has seen no change in the external environment, be it in terms of decision making cycles, pipeline conversions or timely ramp-up of deals. EBIT margins should improve sharply in Q2/Q3 despite the drag from wage hikes given integration of higher margin software products acquired from IBM, right shoring on recently won large deals and efficiency improvements. We see FY20 revenue guidance of 14-16% in CC terms as conservative and would expect HCLT to revise it upwards through the year. Maintain BUY

 

*  Watchful on the external environment but no change in fundamentals on a ground-up basis yet.

HCLT has seen no change in client behavior whether in terms of signing deals or timely ramp-up of the backlog. Company remains confident of delivering growth within the guided range of 14-16% in CC terms and 8-10% excluding revenues from IBM product acquisition. We see the guidance as conservative given the negligible ask rate required over the next three quarters to deliver even the higher end of the range. Though we are cognizant of 1) the revenue drags from structured reductions and impacts from right shoring in recently won large deals, and 2) impact of client specific issues in the BFSI and manufacturing verticals (one each), we still see HCLT delivering positive sequential organic growth in each of the remaining three quarters of the fiscal.

 

*  High conviction in achieving the guided margin range.

EBIT margins had declined by 180bps QoQ to 17.1% in Q1FY20 primarily given the sharp erosion in Engineering Services profitability and preparatory spends for seamless integration of software products acquired from IBM. However, company remains confident in delivering FY20 margins within the guided range of 18.5-19.5% with sharp improvement to be evident in Q2/Q3 despite the drag from wage hikes (likely impact of 40-50bps in Q2FY20 and 70-80bps in Q3FY20). Integration of products acquired from IBM should aid margins by ~70bps in FY20 in our opinion. It is also important to emphasize that though IP has strong seasonality in Q3, EBIT margin benefit from it gets blunted given that amortization of customer contracts happens in-line with revenue generation. We see pyramid optimization and productivity as the two key levers for margin defense over the medium term.

 

*  Maintain BUY.

HCLT has potential to be the fastest growing company within our large cap coverage on an organic basis in FY20. However continuity of growth into FY21 at healthy levels (6-7% organic) would be key for the multiple to re-rate for which deal intake needs to be sustained at high levels. Though primary focus will be to efficiently integrate existing acquisitions, company would still continue to be opportunistic on inorganic if an asset with the right strategic fit were to present itself. In that context, it will be interesting to see how the company approaches other elements of capital allocation especially given the impact of follow-on payments associated with the IBM acquisition in CY20 on the balance sheet. Maintain BUY rating with a revised target price of Rs1,215 based on 14.5x June’21E EPS

 

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