Q2FY24 Review: HCL Technologies: Guidance cut, but optimistic on H2

13 Oct 2023 , 12:06 PM

HCLT reported Q2FY24 USD revenue growth of 1% cc QoQ – in line with IIFLe, driven by sequential improvement in Services. ER&D led growth at 5% cc QoQ, partly driven by ASAP acquisition. IT services rebounded to grow 0.9%, while P&P (-4%) was impacted by seasonality. Ebit margins expanded to 18.5% (+150bps QoQ), above IIFLe at 17.5%. Deal wins came in at an all-time high of USD4bn, boosted by the Verizon mega deal. However, HCLT cut its FY24 revenue organic growth guidance to 4%-5% cc YoY (was 6-8%), implying revenue Cqgr of 2.6%-3.8% and reiterated Ebit margin guidance of 18-19%. The cut in guidance was due to a soft H1 and continued pressure on discretionary spending, in line with analysts of IIFL Capital Services expectations. Analysts of IIFL Capital Services maintain their EPS estimates and 12-month TP of Rs1,270 pegged at 18x 2YF P/E. HCLT is trading at 18.3x on FY25 P/E, at a ~10% discount to large caps. Analysts of IIFL Capital Services believe further re-rating would require consistent delivery on growth/margins. Maintain ADD. 

Sequential growth rebounds:

HCLT Services rebounded in Q2 to 1.6% cc QoQ (1% cc QoQ organic), driven by broad-based growth across verticals ex Technology and Manufacturing. P&P witnessed 4% cc QoQ decline, driven by seasonality. Deal wins were at a record high, providing visibility for a stronger H2. Driven by a soft 1H and continued cautious spending environment by clients, HCLT cut its FY24 organic revenue growth guidance to 4-5% cc YoY (was 6-8% cc YoY) — in line with expectations. 

Margins recover faster than expected: 

At 18.5% (+150bps QoQ), Ebit margins were above IIFLe of 17.5%. HCLT maintained FY24 Ebit margin guidance of 18-19%. Margin tailwinds were productivity improvement, reduction in overhead costs and lower Other discretionary expenses. Management expects sequential improvement in Q3 margins, despite the junior-employee wage hike and Verizon deal ramp-up costs (starts from Nov). Headcount declined by 2.3k, even as attrition cooled off to 14.2%.

Balanced risk-reward:

Analysts of IIFL Capital Services forecast HCLT to deliver 7.7%/9.9% USD revenue/EPS Cagr over FY23-26. The stock has rerated this year to 18.3X on FY25 P/E and is trading at ~10% discount to peers. They believe further re-rating would require consistent delivery on growth/margins, amid a volatile macro. Analysts of IIFL Capital Services TP of Rs1,270 is based on 18x 2YF EPS. Maintain ADD given lack of valuation headroom. Risks: INR, acquisitions.