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Strong commentary on Services, P&P rebuilding to take time

The stock continues to be attractively valued

We attended HCLT’s Analyst Day, where the management reiterated their positive stance on IT Services and ER&D verticals, while detailing the steps being undertaken to return to growth in its struggling Products and Platform (P&P) business. The management reiterated its FY23 guidance of growing revenue by 12-14% and EBIT margin in the 18-20% range, and also introduced its five strategic objectives. We continue to expect strong growth in its Services portfolio in FY23, which should help rerate the stock.

Five strategic objectives to drive value creation

* The management introduced five strategic objectives, which it will focus on to create value for all stakeholders:

*  a) Leadership through differentiated services and products: HCLT expects to differentiate its offerings through innovation, Cloud capabilities, integrated solutions, and accelerators.

*  b) Employer of choice in professional services across geographies: It prides itself on being a company of choice for employees.

*  c) Preferred Digital partner for global 2000 enterprises, with 70% of Tech spends by these entities. HCLT will focus on these clients selectively to transform brands at scale.

*  d) EGS is a major focus area of the company, with support at the board level and a desire to continue to increase diversity.

* e) Top quartile TSR over the medium term: The management’s focus will be to organically grow the business, while maintaining a high capital allocation and sustainability in growth.

Cloud driving spends in IT and business services

* The management is not anticipating any slowdown in technology spends in the current environment, despite an adverse macro-economic environment.

*  It sees Cloud as a key growth factor for the industry, with 51% of Tech spends being skewed towards Cloud by CY25.

* It sees significant opportunities in sub-segments like app and data, Digital workspace, and security and compliance.

Continued growth in legacy and Digital Engineering to aid stability

* The management said Digital Engineering constitutes ~30% of its ER&D vertical and is growing rapidly.

* As the company continues to gain from its traditional/legacy exposure, which provides stability in growth in a moderating demand environment, it remains a cash cow to fund growth in Digital Engineering.

* HCLT sees Digital Engineering, high growth verticals, and high potential geographies (Japan, Germany, and France) as their big bets in ER&D.

Product stabilization and shift to SaaS to keep P&P muted

* HCLT has seen a big expansion in its client portfolio due to the acquired products in the P&P business. It now has a presence in majority of the Fortune 100/500 customers.

* It also provides categorization of products, with weakness in its core products of Horizon 1 (Domino, Sametime, Connections, etc.) being compensated by growth in Horizon 2 (growth products) and Horizon 3 (explore products).

* The management expects growth in the Horizon 1 business to take time to return due to a shift in focus towards a SaaS-based subscription model and streamlining of product sales.

Valuations offer a margin of safety

* Higher exposure to Cloud, which comprises a larger share of non-discretionary spend, offers a better resilience to its portfolio in the current context, with higher demand for Cloud, Network, Security, and Digital workplace services.

* Strong sequential growth within Services, robust headcount addition, healthy deal wins, and a solid pipeline indicates an improved outlook.

* 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 trading ~17x FY24E EPS, which offers a margin of safety. Our TP is based on 21x FY24E EPS. We maintain our Buy rating.

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