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Software business seasonality drives outperformance

HCLT logged a strong operating performance in Q3, aided by its software business. Revenue grew 6% CC QoQ, led by seasonal strength in software (up 32%) and a healthy 3.1% growth in services, propped by the Verizon deal ramp-up and an incremental 2-month contribution from ASAP. EBITM expanded by 130bps QoQ, supported by software business seasonality. Net new-deal intake remained healthy at USD1.9bn in Q3. HCLT has narrowed its overall FY24 revenue growth guidance to 5-5.5% CC (5-6% earlier), implying 0.3-2.1% QoQ revenue growth in Q4; it retains its EBITM guidance at 18-19%. This points to 1.6-3.5% QoQ growth in services, with mgmt target of delivering near the upper end of its guidance. HCLT is not seeing any major uptick in discretionary spend in IT services, but some green shoots are visible in ER&D, along with resilient tech spending in cloud migration, SAP migration, core & data modernization, cyber security, automation, and advance analytics. We tweak FY24-26E EPS by -1.2% to 0.6%, factoring-in the Q3 performance and divestment of stake in its JV with State Street. We retain BUY and TP at Rs1,700, at 23x Dec-25E EPS

Results Summary

HCLT’s revenue grew 5.9% QoQ (6% QoQ/4.3% YoY in CC terms) to USD3.41bn, at a slight beat to our estimates. IT & Business Services grew 1.9% QoQ, while ER&D Services saw a sharp 8.7% QoQ growth (aided by an incremental two-month contribution by the ASAP acquisition; organic: 2.5%). Software revenue grew 32% QoQ on the back of seasonality. While Services revenue growth was a tad below, Software revenue came ahead of our expectations leading to an overall revenue beat. EBITM expanded by ~130bps QoQ to 19.7%, above our estimates of 19.1%, supported by software seasonality (up 180bps) and currency benefits (up 15bps) negating wage hikes for ~90% of the employee-base (down by 65bps). HCL Tech signed 18 large deals—six in Services and 12 in Software—with total new-deal wins worth USD1.9bn. Among geographies, USA and Europe reported growth of 3.1% and 5% QoQ (CC), respectively, while ROW revenue declined 5.3% QoQ due to higher number of furloughs and select project ramp-downs. Five of the seven verticals reported sequential growth, while Financial Services and Life Sciences clocked a decline. Headcount increased 1.6% QoQ to 224,756, after two quarters of decline. The company declared a dividend of Rs12 per share. What we liked: Operating performance beat, healthy deal intake, further moderation in LTM attrition to 12.8%. What we did not like: Poor cash conversion (57% OCF/ EBITDA).

Earnings Call KTAs

i) Company is not seeing an uptick in discretionary spend, but some portion of the tech spends (like cloud migration, SAP, data modernization, cybersecurity, automation and advanced analytics) remain resilient. ii) Gen AI holds immense potential and near-term programs in this segment are likely to be small, albeit expected to become sizable in the next 2-3 quarters. HCLT has signed 31 deals in Gen AI, most of which are valued at subUSD1mn. iii) Reversal of furloughs, one additional month of the Verizon deal ramp-up, other large-deal ramp-ups, and continued momentum in ER&D are likely to drive growth in Services revenue in Q4, thus negating seasonal weakness in the software business. iv) The management expects some furloughs in the APAC region in Q4 as well. v) Financial Services declined 1.3% QoQ, impacted by the higher number of furloughs. vi) The telecom vertical grew 25.9% (CC) QoQ, backed by the Verizon deal, and contributed 2/3rds of incremental Services revenue in Q3. vii) The management remains confident of achieving its medium-term EBITM goal of 19-20%. viii) HCLT rolled out wage hikes for ~90% of its employee-base in Q3, with average pay hike of 5-7%. This wage hike is expected to impact margin by 20-25bps in Q4. ix) DSO (incl. unbilled) was 86 days, hit QoQ by the seasonality in the software business.

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