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Analyst Corner: Buy’ on HCL Tech, mgmt commentary comfortable – The Financial Express

The Financial Express

We expect the robust performance in HCL’s Services business, especially the ER&D vertical, to continue as the demand environment remains favourable. We also draw comfort from improving management commentary on continued growth momentum in the IT Services business.
Sustainable demand momentum for Cloud and Digital Engineering benefits HCLT, given its large presence within IMS and ER&D and continued investments in capabilities. Strong headcount additions and deal wins reflects the management’s confidence on a sustainable growth momentum.
We continue to see potential in HCLT’s Products and Platforms business. While, the recent departure of the head of Products has elevated concerns on business recovery.
On a combined basis, HCLT should deliver USD revenue growth of 13.1% over FY21-23E. We expect EBIT margin to stabilize at 20% in FY23E, which should help it deliver 14.3% PAT CAGR over FY21-23E.
HCLT’s recent revision in payout policy (at least 75% of net income, up from 50%) over FY22-26 is a positive. A higher payout reflects a strategic shift to focus on organic growth and limit inorganic investments to bolt-on and capability based acquisitions (v/s large revenue accretive acquisitions). We maintain our ‘buy’ rating as we expect traction in the Services business in 2HFY22E and FY23E, driven by higher IMS/Cloud-focused deals.
Services business – headcount addition illustrates strength: There is a big divergence between revenue growth and employee addition at HCLT over the last four quarters, which stands out v/s its peers. We view the front ending of employee
addition (~35k over the last four quarters, +22% YoY) as a smart move and a safeguard against the current supply crunch.
It also points to the management’s confidence in growth acceleration in the Services business over the next few quarters, which should help usher revenue growth and employee productivity back to its historical levels. Fresher hiring has seen an acceleration and is expected to rise further. HCLT hired 5.5k freshers in 2Q (v/s 3.5k in 1Q ) and intends to hire 20k freshers in FY22. We expect HCLT to deliver USD revenue growth of 14.1% in Services over FY21-23E.
Products and platforms – a bumpy ride ahead: HCLT’s Products and Platforms business, which also houses software acquired from IBM, has been witnessing multiple challenges like: 1) discontinuation of certain products, 2) decline in 2QFY22 revenue led by end of quarter delays in deal signings, and 3) resignation of Mr. Darren Oberst, CEO, HCL Software.
Leadership attrition in an already challenged business increases the risk to a sustainable recovery. The management’s guidance and commentary for the P&P business has gradually become cautious. We have created a sensitivity analysis, which depicts that even in a bear case (4% decline in P&P revenue in FY23E), the EPS impact is restricted to 2.6%.
Valuations offer a safety margin: Given its deep capabilities in IMS and strategic partnerships, investments in Cloud, and Digital capabilities, we expect HCLT to emerge stronger on the back of an expected increase in enterprise demand for these services. The stock is currently trading ~20.1x FY23E EPS, which offers a margin of safety. Our TP is based on 25x FY23E EPS. We maintain our ‘buy’ rating.
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