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Steady now, strong ahead

Recovery or not; HCLT remains our top pick

* HCL Technologies (HCLT) reported a decent performance in 1QFY25. Revenue stood at USD3.3b, down 1.6% QoQ in constant currency (CC) vs. our estimate of a 1.8% decline. In USD terms, revenue reported growth of 5.1% YoY (5.6% YoY in CC), which was in-line with our estimates. EBITDA witnessed QoQ de-growth of 3.9% but increased 7.4% YoY to INR59b (1.8% above our est. of INR58b). EBIT margins came in 30bp ahead of our estimate at 17.1%. PAT grew 7% QoQ/20.5% YoY to INR43b (13% above our est. of INR38b). New deal TCV stood at USD1.9b (down 14.4% QoQ/up 25% YoY). HCLT maintained its FY25 revenue growth guidance at 3-5% YoY in CC (3-5% YoY in CC for Services).

* Well set up for FY26: HCLT has tackled seasonality in its first quarter well. 2H is generally a strong quarter for HCLT, and the ask rate to achieve the top end of its revenue guidance is 2.5%, which we consider quite achievable even if the demand environment does not materially improve. We believe a strong 2H positions HCLT well for a strong FY26. We assume a CQGR of 2.1% in FY26E.

* HCLT should command a multiple premium: This implies HCLT would have outperformed Infosys for three straight years on growth. Further, HCLT’s FCF metrics have meaningfully improved during this time and are now comparable to both TCS and Infosys. We believe this warrants a multiple premium to Infosys. As shown in exhibit 11, during the years of outperformance, HCLT has traded at a premium to Infosys for considerable periods in the past (10 years), and we believe its current performance warrants this re-rating. We thus upgrade our target multiple to 27x (~10% premium to Infosys).

* EBIT margin declined 50bp QoQ to 17.1% due to a reduction in IT Services margin (from ER&D segment), but beat our estimate by 30bp. HCLT witnessed a net headcount reduction of more than 8k (-3.6% QoQ), largely due to the divestment of its JV with State Street. The management maintained FY25 EBIT margin guidance in the range of 18.0-19.0%, and we believe the company should report near the lower end of the guided range.

* We expect HCLT’s margins in IT services to recover in the next three quarters; however, there is an overhang of wage hikes for the year. We expect HCLT to deliver 18.3% EBIT margin in FY25, which should recover to 18.6% in FY26 as growth improves. We expect HCLT to deliver a CAGR of 7.2%/9.6% in USD revenue/INR PAT over FY24-26E.

* Our positive view on HCLT remains tethered to its business profile, which should continue to benefit in the current macro environment. Its investments in next-gen platforms also position the company well for a recovery in client spending.

* We keep our estimates unchanged. Reiterate BUY with a TP of INR1,850 (based on 27x FY26E EPS). HCLT remains our top pick in large cap IT

Beat on revenue growth and margins

* Revenue declined 1.6% QoQ in CC vs. our estimate of a 1.8% decline. New deal TCV stood at USD1.9b, down 14.4% QoQ/up 25% YoY, in 1QFY25.

* EBIT margin was 17.1%, 30bp above our estimate of 16.8%.

* For FY25, revenue growth guidance is maintained at 3-5% YoY in CC (3-5% CC for Services). EBIT margin guidance is maintained at 18.0-19.0% in FY25.

* PAT grew 7% QoQ/20.5% YoY to INR43b (13% above our est. of INR38b). ? LTM attrition was up 40bp QoQ at 12.8%. Net employee headcount declined by 8k QoQ in 1QFY25.

* LTM FCF to net income stood at 133%.

* The management declared a dividend of INR18/share.

Key highlights from the management commentary

* HCLT is optimistic about growth improvement in 2QFY25 compared to 1QFY25, both at the company and IT services levels. Sequential growth is expected across verticals and geographies, except for the Financial Services vertical, which will be affected by State Street divestment (~80bp impact).

* Financial Services: Expected to decline due to State Street impact.

* Manufacturing: Decline due to productivity issues and stress in the European automotive sector, but anticipated to see good growth in 2QFY25.

* Guidance: Maintained services revenue growth at 3-5% and EBIT margin at 18- 19%.

Valuation and view: Offers margin of safety; reiterate BUY

* Upgrade HCL target multiple: HCLT would most likely outperform Infosys for three straight years on growth. Further, HCLT’s FCF metrics have meaningfully improved during this time and are now comparable to both TCS and Infosys. We believe this warrants a multiple premium to Infosys. As shown in exhibit 11, during years of outperformance, HCLT traded at a premium to Infosys for considerable periods in the past, and we believe its current performance warrants this re-rating. We thus upgrade our target multiple to 27x (~10% premium to Infosys).

* We keep our estimates unchanged. Reiterate BUY with a TP of INR1,850 (based on 27x FY26E EPS)

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