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HCL is a leading global IT services company that ranks among the top five Indian IT services companies in terms of revenues. Since its inception into the global landscape after its IPO in 1999, HCL has focused on ‘transformational outsourcing’, and offers integrated portfolio of services including software-led IT solutions, remote infrastructure management, engineering and R&D services, and BPO services. HCL leverages its extensive global offshore infrastructure and network of offices in 50 countries to provide multi-service delivery in key industry verticals including financial services, manufacturing, aerospace & defense, telecom, retail & CPG, life sciences & Healthcare, media & entertainment, travel, transportation & logistics, automotive, Government, energy & utilities.

HCL Tech’s (HCLT) operating performance has relatively been steady for the Consolidated business, while the Service business (IT + ER&D) has delivered remarkable performance over the last two years, up ~15% YoY in CC terms each in FY22 and FY23. HCLT derives ~60% of its revenues from verticals that are relatively insulated from current macro uncertainties. However, it also has a dependency of ~40% on verticals that are currently facing significant challenges (Financial Service, Retail, and Telecom).

The near-term Service business has been adversely impacted by reduced discretionary spends, which is expected to see a sharp recovery (especially ER&D service line) as the macro challenges taper off. We anticipate the ongoing structural outsourcing trend in the ER&D industry to continue, driven by its inclination to adopt emerging new technologies and streamline product development cycles. The ER&D service business (~16% of revenues) has registered a CAGR of 15.1% over FY21-23.

The acquisition (ASAP) would further pivot its capabilities from core engineering practices to Digital Engineering within the Automotive sector. This strategic move aligns with the strong growth potential and positive spending outlook for major OEMs.

Additionally, HCLT’s investments in building a senior leadership team and enhancing capabilities are yielding positive results, evidenced by securing large deals (0.8x BTB) in 9MFY24. The conversion of Verizon’s multi-year mega deal is a validation of strengthening capabilities that too in the space that is undergoing a challenging environment.

HCLT’s business mix is relatively more resilient to the adverse macro environment. Even the vertical mix is evenly distributed with individual strengths, while its service lines (cloud + IMS) have been more biased and relevant toward current enterprise spends. Given its robust capabilities and scale in ER&D space, and continued investment to drive Digital engineering revenue with strong outsourcing opportunity should provide sustainable and predictable growth going forward we recommend a Buy on the stock.

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