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Traction in Services to cushion the pain in Products

Expect mid-teen growth in FY22; Maintain Buy

* HCLT delivered in line revenue growth (2.5% QoQ CC) in 4QFY21, led by strong traction in IT Services (+4.4%), but partially offset by muted ER&D (+0.7%) and a fall in Products and Platforms (-4.9%) due to seasonality and client-specific weakness. EBIT margin (adjusted for one-time bonus impact of 370bp) fell 250bp QoQ to 20.4% on wage hike (60bp), seasonality in Products and Platforms (70bp), higher fresher hiring (60bp), forex (20bp), and impairment charges (60bp). The management guided at double-digit USD revenue growth and 19-21% as the EBIT margin band for FY22.

* It resumed sharing TCV, disclosing USD3.1b (+49% YoY, 19 large deals) in new deal wins during 4Q, and FY21 TCV of USD7.3b (+18% YoY). HCLT saw an increase in its qualified pipeline despite a good conversion in FY21.

* We see HCLT deliver over 15% USD revenue growth in IT Services led by: a) a good demand environment, b) strong exit to FY21 (+5.2% QoQ USD reported growth), and c) large deal win momentum. While ER&D’s performance (~16% of revenue, -4.6% YoY) was disappointing in FY21, the management indicated a strong FY22, with a rebound in 1Q.

* While we were disappointed by the outlook of low single-digit growth for Products in FY22 (primarily due to discontinuation of some products), we remain confident of HCLT growing in low teens (~13% YoY CC growth) on the back of improvement in IT Services and ER&D verticals. We continue to see higher potential for the Products and Platforms vertical in the medium term and expect it to return to double-digit growth in FY23.

* We see a wage hike, lower Products and Platforms growth, and sales & marketing investments as margin headwinds in FY22, which should more than offset the benefits from growth-led positive operating leverage. We expect the company to report 20.3% EBIT margin, down 120bp YoY adjusted for one-time bonus and impairment charge, but flat on a reported basis. The management has indicated a preference for growth in the current environment given the opportunities in the market.

* For FY21, it delivered sales (USD)/EBIT/PAT growth of 2.4%/11%/7%. Cash conversion remained strong, with Operating Cash Flow/Free Cash Flow up 49%/58% to USD2.6b/USD2.3b. Cash conversion stood at 155% (OCF/NI) and 139% (FCF/NI).

* We downgrade our FY22E/FY23E EPS estimate by 8.5%/7%, led by a PAT miss during 4QFY21. We factor in lower growth in the Products and Platforms business and higher sales and marketing investments in FY22E. We maintain our Buy rating as we expect traction in the Services business, driven by higher IMS/Cloud focused deals. Our TP of INR1,190 per share implies 20x FY23E EPS.

Valuation and view – Subdued multiples offer a safety margin

* HCLT’s exposure to deeply troubled verticals – Energy, Transportation, Travel, Hospitality, and Retail – are lower v/s its peers. It has a higher exposure to Financial Services, Technology Services, and Life Sciences, where we anticipate a better outlook.

* Higher exposure to IMS (~37% of revenue), comprising a larger share of nondiscretionary spend, offers a better resilience to its portfolio in the current context, with increased demand for Cloud, Network, Security, and Digital workplace services.

* Broad-based sequential growth, coupled with healthy deal wins and a robust pipeline, indicates an improved outlook. We estimate strong performance in the Products business, led by HCLT’s capabilities to rightly align and sell these products in the long run.

* Given its deep capabilities in the IMS space and strategic partnerships, investments in Cloud, and Digital capabilities, we expect HCLT to emerge stronger on the back of an expected increase in enterprise demand for these services. The stock is currently trading at a modest ~16x FY23E earnings, which offers a margin of safety. Our TP is based on 20x FY23E EPS. Maintain Buy.

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