Buy HCL Technologies Ltd For Target Rs.1,300 - Motilal Oswal
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Valuations continue to discount Product opportunity
HCLT remains one the most attractive stocks in our coverage, trading at 15x FY23E P/E (38%/26% discount to TCS/Infosys), despite delivering 20% earnings growth in FY21 YTD. We expect this discount to narrow as it benefits from increasing Cloud spend, given its large exposure to IT infrastructure. It can potentially re-rate if it continues to deliver growth in the Software Product business, which remains a key overhang on the stock price, despite outperforming expectations over the last two quarters.
Cloud remains a large opportunity
* We view Cloud deployment and application migration to be among the biggest areas of corporate spend in the medium term, growing at 15-18% CAGR between CY20-25E (Exhibit 3).
* With its high exposure to Infrastructure Management Services (over 30% of total revenue), HCLT would be one of the key beneficiaries to the Cloud shift. It continues to be rated among the top vendors by industry analyst in the Cloud migration space.
* We expect HCLT’s Mode 2 business to grow at 26% CAGR over FY20-23E to reach 28% of total revenue in FY23E.
P&P performing better than expected
* HCLT has delivered double-digit growth (over 13.4% YoY growth in six months ending Dec’20) in its IBM software-led Product and Platform (P&P) business. This should help address investor concerns since the acquisition of these IP in Dec’18, mainly on account of legacy software like Domino/Lotus Notes.
* We expect this business to continue to grow well and deliver 13% revenue CAGR over FY21-23E. Despite the investment impact, we expect EBIT margin to stay meaningfully above IT Services profitability.
* With the upcoming launch of Domino V12 (third major update in 2.5 years after the last update under IBM in CY13) and a large user base (partially dormant), we see upside risk for P&P growth led by client upgrades.
* We expect the drag from a large investment on HCLT’s RoIC to bottom out in FY21E (Exhibit 10 and 11).
Valuation and view
* Higher exposure to IMS (over 30% of revenue), aided by strong demand for Cloud services, should help deliver over 14% revenue growth in FY22E.
* Broad-based sequential growth, coupled with healthy deal wins and a robust pipeline, indicates a good demand outlook. We expect strong performance in the Products business, driven by HCLT’s capabilities to rightly align and sell these products.
* 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 ~15x FY23E earnings, which offers a margin of safety. Our TP is based on 20x FY23E EPS (a 20% discount to TCS). Maintain Buy.
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