Fitch affirms HCL Technologies at 'A-'; Outlook stable

28 Mar 2022 , 06:22 PM

Fitch Ratings has affirmed India-based HCL Technologies Limited’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) at ‘A-‘. The Outlook is Stable. We have also affirmed HCL’s senior unsecured rating of ‘A-‘ and the ‘A-‘ rating on the USD500 million senior notes due 2026 issued by HCL America Inc. and guaranteed by HCL.

The ratings reflect HCL’s strong market position in the global IT service industry, leadership in the engineering and R&D segment, buoyant industry growth, robust profitability and cash generation, and a highly conservative capital structure. We expect HCL to maintain its net cash position over the medium term.

Key Rating Drivers

Global Service Provider: HCL became the third-largest Indian IT service company by revenue after Tata Consultancy Services Limited (TCS, A/Stable) and Infosys Limited when it overtook Wipro Limited (A-/Stable) from the financial year ended March 2019 (FY19). HCL has a strong globally diversified presence and provides comprehensive IT services to an established customer base.

Diversified Customer Base: HCL has low customer concentration with its five-largest and 10-largest clients contributing 13% and 21% of total revenue, respectively, in FY21. Its end-customers are also spread across industry segments. Financial service clients accounted for 22% of revenue in FY21, followed by manufacturing (18%), technology and services (17%) and life sciences and healthcare (14%). The diversified exposure gives HCL a more stable revenue pipeline than peers, which mostly have higher customer or industry concentration.

Robust Profitability and Cash Generation: HCL’s rating is supported by strong profitability and solid operating cash generation. We forecast its Fitch-adjusted EBITDA margin to be around 23% in the medium term, lower than FY21’s 26%, due to intense competition for talent, reversal of pandemic-related savings and a change in the service mix. The Fitch-adjusted EBITDA margin of 23% is also in line with HCL’s historical average.

Strong Industry Growth Potential: We expect a robust order pipeline to boost global IT companies’ revenue growth in FY22-FY23. Businesses across various industries and countries are increasingly engaging IT service companies on digital transformation such as customer and employee experience and supply-chain management. IT service spending will rise by 8% in 2022 and 9% in 2023, according to research firm Gartner. We expect Indian IT companies to expand faster than the industry average as they have lower staff costs than global peers.

Fitch expects demand for next-generation technology, such as artificial intelligence, 5G, cybersecurity, digital strategy and cloud services, to grow faster than traditional IT services. These will require greater capability from IT service providers, such as strong industry expertise, trained talent and technology stacks. We believe industry-leading IT companies, including TCS, HCL and Wipro, are well-positioned to serve these needs in light of their large operating scales and financial resources available for further investments.

Net Cash Position: HCL had a net cash position of around USD2 billion at end-2021, based on Fitch’s estimates. We expect HCL to maintain its net cash position as we forecast a high pre-dividend free cash flow (FCF) margin of around 15% in the medium term, which will mainly be used to fund shareholder returns in the form of dividends and share buybacks, and small acquisitions. We believe HCL has the flexibility to adjust its shareholder return policy, depending on the business environment and its financial position.

HCL has no plans to raise additional domestic or foreign debt. Its only major outstanding debt is the USD500 million senior notes due 2026.

No Country Ceiling Constraint: The Foreign-Currency IDR is same as the Local-Currency IDR as we assess the applicable Country Ceiling for HCL at ‘AAA’. We believe the profit from its overseas subsidiaries in countries with Country Ceilings of ‘AAA’ is sufficient to support a reasonable amount of foreign-currency debt, even though HCL has no intention of raising such debt.