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Growth optionality at attractive valuation

Expect strong growth momentum in FY23E; maintain Buy

* HCLT delivered a growth of 0.7% QoQ (CC), below our estimate of 2.4%, led by weak growth in IT Services (+0.5%) and Products & Platforms (-1%), but partially compensated by better than expected ER&D (+4.5%). Excluding the impact of a one-time bonus in 4QFY21, EBIT margin was down 80bp QoQ and missed our estimate by 130bp due to COVID-related expenses of 90bp. The management reiterated its double-digit USD revenue growth guidance and EBIT margin band of 19-21% for FY22.

* New deal TCV stood at USD1.7b (+37% YoY, eight large deals) in 1QFY22. Deals saw an increase in tenure, with a higher proportion of Cloud-centric Digital transformation programs. While growth in 1QFY22 was impacted by supply-related challenges (60-70bp) and project completion in Europe, we expect HCLT to deliver 11.5% USD revenue growth in FY22, led by a good demand environment and strong deal pipeline in Europe and US. The company should also benefit from a strong rebound in ER&D.

* While its FY22 growth guidance for the Products and Platforms business remains in low single-digits, we remain confident of HCLT growing in low teens on the back of an 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 FY23E (we estimate 13.6% CC USD growth).

* We see a wage hike, lower Products and Platforms growth, and sales and marketing investments as margin headwinds in FY22. This should more than offset the benefits from growth-led positive operating leverage and reversal of COVID-related costs in 1Q. We expect the company to report 19.9% EBIT margin, down 50bp YoY on a reported basis. The management has indicated a preference for growth, given the opportunities in the market.

* We downgrade our FY22E/FY23E EPS estimate by 4%. We factor in a revenue miss and lower growth in the Products and Platforms business. We have reduced our margin estimate to factor in higher sales and marketing investments in FY22E. We maintain our Buy rating as we expect traction in the Services business in 2HFY22E and FY23E, driven by higher IMS/Cloud focused deals. Our TP of INR1,180 per share implies 20x FY23E EPS.

Miss on both topline and margin; guidance intact

* In USD terms, revenue grew 15% YoY (est. 17%), operating profit rose 7% (est. 16%), and PAT increased by 10% (est. 15%) in 1QFY22.

* In constant currency terms, revenue grew 0.7% QoQ in 1QFY22, below our estimate of 2.4%.

* The company posted a weak growth in IT Services (+0.5% QoQ) and Products and Platforms (-1%), but ER&D was above our estimate (+4.5%). It shifted USD6m in revenue to Products and Platforms (+170bp impact) from ER&D (-150bp impact QoQ).

* Mode-1/2 (61.5%/23.7% of the business) grew 0.8%/2.3% QoQ, while Mode-3 (14.8%) declined by 2% in constant currency terms.

* Growth was driven by Financial Services (+2.9% QoQ CC) and Technology and Services (+1.6% QoQ). This was partially offset by a decline in Manufacturing (- 2.2% QoQ) and Retail and CPG (-0.1%).

* New deal TCV grew 37% YoY to USD1.7b in 1QFY22, led by eight large service deal wins and four products wins. This was down QoQ from a record USD3.1b.

* Margin rose 300bp QoQ to 19.6%. Excluding the impact of a one-time bonus in 4QFY21, EBIT margin was down 80bp QoQ and missed our estimate by 130bp.

* PAT stood at INR32b (up 10% YoY) as against our expectation of INR34b, a miss of 4.4% on lower operating income and margin.

* The management guided at double-digit revenue growth in CC terms in FY22.

* EBIT margin is expected to be in the 19-21% range in FY22.

* In 1QFY22, Operating Cash Flow/Free Cash Flow stood at USD447m/USD403m. Cash conversion was at an OCF/NI of 102% and a FCF/NI of 93%.

* Gross/net cash stood at USD2.6b/USD2b as of 30th Jun’21.

* IT Services Attrition (LTM) stood at 11.8%, up 190bp QoQ. Net additions stood at 7,522 in 1QFY22.

* The company declared a dividend of INR6 per share.

Key highlights from the management commentary

* HCLT reported 0.7% QoQ (CC) growth during 1QFY22. New deal TCV grew 37% YoY to USD1.7b led by eight large service deal wins and four products wins.

* There is not much to read into the sequential dip in Europe as the pipeline remains very strong. The geography remains a medium term investment strategy for the company and robust growth is expected in the coming quarters.

* The management expects robust growth in the coming quarters on the back of strong headcount addition and increased deal ramp up.

* The Products and Platforms segment is expected to grow at a low to mid-single digit growth rate in FY22. The same should increase over the next couple of quarters.

* In terms of margin, increased investments in geographies should be a headwind. The management expects them to be in the 19-21% range.

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 ~17x FY23E earnings, which offers a margin of safety. Our TP is based on 20x FY23E EPS. We maintain our Buy rating.

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