Buy HCL Technologies Ltd For Target Rs.2,200 by Motilal Oswal Financial Services Ltd
Short-term uncertainty, long-term value
We met with Mr. Shiv Walia, the CFO of HCL Technologies (HCLT), and left with a positive view on the company's growth quality despite the near-term uncertainties. Management highlighted that deal durations are shortening, with larger deals being broken into smaller chunks, though the pipeline remains strong, and deal momentum is improving. While we have tempered growth expectations due to a slower exit in 3Q and 4Q, HCLT’s differentiated positioning in hi-tech and semiconductors, along with its low reliance on pass-through revenues, bodes well for the medium term. The HP CTG acquisition reinforces its telecom presence, diversifying exposure beyond North America and enhancing its capabilities in network solutions. On margins, Project Ascend is driving efficiencies, helping to offset cost pressures, and while shorter deal durations may affect predictability, HCLT remains focused on reinvesting in growth. We now value HCLT at 28x FY27E EPS (vs. 30x earlier) owing to a slower-than-expected discretionary pick-up across the industry. We reiterate our BUY rating with a TP of INR2,200.
Key highlights from our discussion
* Deal trends: Management reiterated that deal durations are shortening, with larger deals being split into smaller chunks. The deal pipeline is near all-time highs, and if conversions materialize, Total Contract Value (TCV) could rise from USD 2b to USD 2.3-2.5b. The Annual Contract Value (ACV) grew 23% YoY in 3QFY25, reflecting this trend.
* Growth outlook: While near-term uncertainty remains, HCLT’s growth quality is strong. We estimate ~6.5% YoY growth in constant currency for FY26e; a softer 3Q and 4Q exit has tempered expectations. A stronger discretionary spending environment could present an upside risk to these numbers.
* Growth quality vs. peers: HCLT has the lowest pass-through revenue contribution among peers, signaling higher-quality growth. While passthrough revenues are necessary for cost-takeout deals and GCC setups, HCLT’s control over these low-margin revenues is commendable.
* Hi-Tech exposure favorable to industry tailwinds: HCLT works with 8 of the top 10 R&D spenders in the hi-tech space. In the semiconductor space, HCLT has one of the most diversified service offerings, spanning chip design, assembly, testing, validation, and platform solutions. Hi-tech, along with the US BFSI, should be one of the fastest-growing verticals in FY26E, in our view, and HCLT's differentiated offerings in this space position its hi-tech vertical well for the next 12-18 months.
* HP CTG acquisition could unlock new geographies but hurt margins: The HP CTG acquisition expands HCLT’s telecom footprint; HP CTG works with 25 of the top 30 global communication service providers (CSPs), helping HCLT diversify away from North America and expanding its footprint in Europe and Japan, providing deeper access to high-value telecom engineering and network transformation projects. We note, however, that the acquisition is dilutive to margins and could present near-term risks to its profitability.
* The TMT vertical, after a torrid couple of years, could begin to turn around in FY26E, and the company expects the vertical to do well in the coming year.
* Margins & FY26 outlook: Project Ascend is driving efficiency gains, offsetting wage hikes. Shorter-duration deals may reduce margin predictability, but FY26 is expected to be a stable margin environment. HCLT may reinvest gains, yet margins could still improve by 30bp, per our estimates.
Valuations and View
* We expect HCLT to deliver an 18.2% EBIT margin in FY25, which should recover to 18.6% in FY26 as growth improves. We expect HCLT to deliver a CAGR of 6.2%/10.3% in USD revenue/INR PAT over FY25-27E. We now value HCLT at 28x FY27E EPS (vs. 30x earlier) owing to a slower-than-expected discretionary pickup across the industry. We reiterate our BUY rating with a TP of INR2,200
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