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HCL Technologies (HCLT) has reported a beat on revenue growth as well as margins in Q2FY23. It reported revenue growth of 3.8% QoQ CC (I-Sec: 3%, Cons: 3%) and 1.9% QoQ in US$ terms. Growth was led by IT services at 5.3% QoQ CC and ER&D at 5% QoQ CC. Products business declined 7.8% QoQ CC due to seasonal weakness.

TCV of new deal wins was healthy at US$2,384mn (up 6% YoY, up 16% QoQ). ACV is up 10.3% QoQ and up 23.5% YoY. HCLT won a mega deal with ACV of US$125mn over 5 years. HCLT’s presence in P&P business helped it gain access to this new client and win this mega deal. Management for the first time provided revenue guidance for the services business of 16-17% YoY CC growth. Services business (IT+ER&D) grew 19% YoY CC in H1FY23 and the guidance factors in slowdown due to furloughs in H2FY23. Management upgraded overall revenue guidance to 13.5-14.5% YoY CC growth from earlier 12-14% YoY given healthy bookings in H1FY23 and healthy pipeline.

HCLT has reported a beat on EBIT margin at 18% (+100bps QoQ) vs our estimate of 17.5%. Services (IT+ER&D) margin improved 134bps QoQ. Margin walk: Tailwinds of 1) 115bps from increase in realisation and utilisation, 2) 45bps operating leverage reflected in lower SG&A as % of revenue, and 3) 55-60bps from INR depreciation partially offset by 92bps impact of wage hike rolled out effectively from 1st July for majority of employees. HCLT is able to improve realisation from existing customers as well as on new deals.

Management narrowed its EBIT margin guidance to 18-19% from earlier 18-20% for FY23. H1FY23 margin stands at 17.5% and the company expects to improve margins in the next two quarters despite seasonal weakness in products business in Q4FY23. Key margin levers ahead are pyramid optimisation and scope for improving utilisation. We model 18% EBIT margin, near lower end of guidance implying 18.5% margin in H2FY23

As per our estimates, YoY cross currency headwinds for FY23 calculated assuming current FX rates remain constant stand at ~470bps. Our US$ revenue estimates increase slightly by 1.3%/1.7% for FY23/24 led by beat in Q2FY23 and healthy bookings. We slightly increase our margin estimate by 10bps to 18% for FY23. Our EPS estimates increase by 2.3%/3.5% for FY23/24 led by increase in revenue, margin and USD/INR assumptions, respectively. We upgrade HCLT to ADD from HOLD as we believe HCLT’s risk-reward has become favourable, as the stock's 2Yr fwd P/E discount to TCS/INFY is higher than the long-term average and has room to narrow & and it has raised guidance for FY23; order intake has been strong for the last few quarters & strong dividend yield provides a floor, limiting downside risk. The stock trades at 17.8x / 15.9x P/E on EPS of Rs53.6 / Rs59.9 for FY23E / FY24E. We value HCLT at 17x on FY24 EPS to arrive at a fair value of Rs1019.

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