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FY24 revenue growth guidance remains punchy but achievable

* HCL Technologies (HCLT) reported a weak 2QFY24 as revenue grew 1.0% QoQ in constant currency (CC) to USD3.2b (below our estimate of 2.9% QoQ CC). HCLT reported consolidated organic growth of 0.5% QoQ CC, with the one-month integration of ASAP contributing 0.5% to overall growth. A slowdown in demand was more pronounced than anticipated in 2Q due to lower discretionary spending and the reprioritization of spending to core operations. ER&D reported 5.0% QoQ CC growth, while organic growth was 1.6% QoQ CC. Despite the softness in 2Q, HCLT reported its highest-ever NN deal TCV of USD3.97b (including Verizon deal) vs. 1.56b in Q1. The deal pipeline remains healthy and HCLT is chasing multiple opportunities in the emerging technologies.

* EBIT margin improved by 150bp QoQ to 18.5%, beating our estimate by 80bp, aided by robust cost-control measures undertaken in 1H and rationalizing employee pyramid. The company saw a second consecutive quarter of net headcount reduction by more than 2k, which, along with the optimization of subcon expenses, contributed significantly to margin improvement. With a strong margin outperformance, HCLT remains confident of achieving its margin guidance of 18-19%.

* While a cut in its FY24 revenue growth guidance (+5.0-6.0% YoY CC from +6.0-8.0% YoY CC earlier) was disappointing, the management has indicated high confidence in achieving the revised guidance due to the ramp-up of the mega Verizon deal, 3Q seasonality in the P&P business and strong bookings in 2Q. This implies a solid quarterly run rate in 2HFY24, which we expect to be the best among our Tier 1 IT services coverage. We expect this to support the share price despite the near-term weakness.

* On the margin front, HCLT’s decision to skip management-level increments (large part of wage bill) should aid profitability in the near term. We expect strong revenue growth and continued cost-control measures in 2H to provide operating leverage and support the overall margin improvement. EBIT margin should recover to 18.6% in FY25 as growth returns, leading to a CAGR of 7.2%/9.7% in USD revenue/INR PAT over FY23-25E.

* The stock is currently trading at an inexpensive valuation of 18.6x FY25E EPS (4.8% Payout yield) and any near-term correction should make it more attractive.

* We have lowered our FY24/25 EPS estimates by 1.6/3.0% to account for the 1Q miss. Reiterate BUY with a TP of INR1,410 (based on 21x FY25E EPS). 

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