Buy HCL Technologies Ltd For Target Rs.2,400 by Motilal Oswal Financial Services Ltd
Guidance upgrade dampens enthusiasm
3Q organic revenues miss estimates, but CY25 outlook upbeat
* HCL Technologies (HCLT) reported a revenue of USD3.5b, up 3.8% QoQ and 4.1% YoY in constant currency (CC), above our estimate of 3.7% QoQ CC growth (largely owing to one-month inorganic contribution from HPE CTG acquisition). EBIT margins came in at 19.5%, beating our estimate of 19.1%. New deal TCV stood at USD2.1b (down 5.5% QoQ) in 3QFY25. For FY25, the revenue growth guidance has been upgraded to 4.5%-5.0% YoY cc (including a ~50bp contribution from the HPE CTG acquisition, with organic growth at 4.0%-4.5%) from the earlier range of 3.5%-5.0%. For 4QFY25, the implied organic growth for ITB&S is now in the range of -1.6% to +0.6% QoQ in cc, which is a downgrade, in our view. For 9MFY25, revenue/EBIT/PAT grew 6.6%/6.5%/11.7% compared to 9MFY24. We expect revenue/EBIT/PAT to grow by 7.3%/6.6%/7.3% YoY in 4QFY25. We reiterate our BUY rating on HCLT with a TP of INR2,400, implying a 21% potential upside.
Our view: Implied 4Q growth for IT&BS soft
* HCLT’s 3Q numbers and 4Q guidance were underwhelming. The implied organic growth rate for IT&BS in 4Q is approximately 0.6% in CC at the upper end of the guidance. Management attributed this to a planned ramp-down in the Verizon deal and some project completions. However, in an environment where short-cycle deals are gaining momentum, the slower ramp-up of discretionary deals in 4Q is a dampener.
* We previously argued HCLT should trade at a roughly 10% premium to Infosys (see our 1QFY25 HCLT RU - Steady now, strong ahead). This was owing to its superior outperformance to its peers over the past 2-3 years, with improving capital allocation and free cash flow metrics.
* Valuation parity is now achieved for the big three—HCLT, TCS, and Infosys. The hurdle rate for HCLT to now re-rate is higher than its peers.
* Nonetheless, we believe HCLT’s diversified portfolio is well-positioned. Often perceived as defensive, its strengths in data, product engineering, and modernization should enable it to benefit from the recovering demand environment.
* More importantly, a 23% increase in ACV (which HCLT started reporting this quarter) despite a muted TCV bodes well for short-cycle deals and should continue to benefit HCLT in the medium term.
Valuations and changes in estimates
* We expect HCLT to deliver 18.2% EBIT margin in FY25, which should recover to 18.9% in FY26 as growth improves. We expect HCLT to deliver a CAGR of 7.5%/11.7% in USD revenue/INR PAT over FY25-27E. We keep our estimates largely unchanged.
Beat on revenues and margins
* Revenue grew 3.8% QoQ in CC vs. our estimate of 3.7% growth (lower than consensus estimates of 4.2%). New deal TCV stood at USD2.1b (down 5.5% QoQ, up 8.7% YoY) in 3QFY25.
* IT business/ER&D business/P&P grew by 1.5%/5.4%/18.7% QoQ CC.
* EBIT margin was 19.5%, beating our estimate of 19.1%.
* For FY25, revenue growth guidance was upgraded to 4.5%-5.0% YoY in CC (similar for IT Services) from 3.5%-5.0%. EBIT margin guidance was maintained at 18.0-19.0% in FY25.
* PAT was up 8.4% at INR46b (up 5.5% YoY) vs. our est. of INR45b.
* LTM attrition was up 30bp QoQ at 13.2%. Net employee headcount increased 1.0% QoQ in 3QFY25. HCLT added 2,014 freshers (2,932 in 2Q) in this quarter.
* LTM FCF-to-net income stood at 134%.
* HCLT declared an interim dividend of INR18/share, including a special dividend of INR6/share.
Key highlights from the management commentary
* The company anticipates increased technology spending in CY25, driven by transformation and efficiency-related initiatives. Discretionary spending is expected to improve overall.
* Growth in small deals was observed, aligning with client spending patterns. Deals were largely driven by AI transformation projects, with a noticeable reduction in average deal cycles.
* 4Q outlook: A planned reduction in megadeals is expected. Discretionary deal ramp-ups in the telecom sector will taper off in 4Q. Declines are anticipated in the telecom and retail sectors in 4Q, leading to a softer quarter.
* BFSI: The company sees continued momentum in client spending. AI adoption is moving from proof-of-concepts (POCs) to enterprise-level implementations in this vertical. Medium and large-sized deals in platform modernization enabled by AI are being observed in Europe.
* Margin walk: Software business contributed 114bp improvement, while services dropped 22bp.
* Guidance: For FY25, the revenue growth guidance has been upgraded to 4.5%- 5.0% YoY cc (including ~50bp contribution from the HPE CTG acquisition, with organic growth at 4.0%-4.5%) from the earlier range of 3.5%-5.0%. Implied organic growth rate for IT Services in 4Q is now 1.6% to 0.6% QoQ. EBIT margin guidance maintained at 18.0%-19.0%.
Valuation and view
* We expect HCLT to deliver 18.2% EBIT margin in FY25, which should recover to 18.9% in FY26 as growth improves. We expect HCLT to deliver a CAGR of 7.5%/11.7% in USD revenue/INR PAT over FY25-27E. We keep our estimates largely unchanged. Reiterate BUY with a TP of INR2,400 (based on 30x FY27E EPS).
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