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  • CMP : 1,673.2 Chg : 0.80 (0.05%)
  • Target : 1,220.0 (15.64%)
  • Target Period : 12-18 Month
Result Update

13 Jan 2023

Vendor consolidation opportunity likely provides growth potential…

About The Stock

HCL Technologies (HCLT) offers IT, ER&D and products to BFSI, retail, health, telecommunication, manufacturing, media & hi-tech verticals.

  • HCL Tech has 250 Fortune 500 and 650 global 2000 clients
  • It has grown organically and inorganically (13% CAGR over FY17-22)
Q3FY23 Results:

HCLT reported strong numbers aided by P&P.

  • The company reported 5% QoQ in CC terms while IT services grew 2.1% QoQ in CC terms. P&P grew 30.5% QoQ in CC terms due to seasonality
  • EBIT margin at the company level grew ~160 bps QoQ to 19.6%
  • Reported steady TCV of US$2.3 billion (bn), down 1.6% QoQ & up 9.9% YoY
What should Investors do?

HCLT’s share price has grown by ~2.3x over the past five years (from ~₹ 458 in January 2018 to ~₹ 1,055 levels in January 2023).

  • We maintain our BUY rating on the stock
Target Price and Valuation

We value HCLT at ₹ 1220 i.e. 19x P/E on FY25E EPS.

Key Triggers for future price performance
  • The company continues to win multiyear deals in Cloud transformation, cyber security, etc, as new deal bookings continue to be strong
  • Revenue guidance of 13.5-14% revenue growth in CC for FY23E at the company level & IT services guidance of 16-16.5% provided visibility for steady growth
  • Revival of P&P business is critical as it is a high margin business
  • With improvement in large deal wins, vendor consolidation opportunity, expansion in geographies, investment in sales & capabilities, we expect HCLT to register 12.3% CAGR in revenues over FY22-25E
Alternate Stock Idea:

Apart from HCLT, in our IT coverage we also like TechM.

  • Key beneficiary of uptick in communication spend
  • BUY with target price of ₹ 1,240

Particulars

Particulars (₹ crore) Amount
Market Capitalization 454,050.4
Total Debt 3,923.0
CC&E 18,875.0
EV 271,168.7
52 week H/L (₹) 2,012.2/1,302.8
Equity Capital 543.0
Face Value (₹) 2.0

Price Chart

Recent Events & Key Highlights

  • Cut revenue and EBIT margin guidance at upper level by 50bps
  • Key Risks: (i) Lower than expected growth ii) Lower than expected margins

Research Analyst

Sameer Pardikar
sameer.pardikar@icicisecurities.com

Result Update
ICICI Securities – Retail Equity Research

Key Financial Summary

Particulars FY20 FY21 FY22 5 Year CAGR(FY17-FY22) FY23E FY24E FY25E 3 Year CAGR (FY22-FY25E)
Net Sales 70,678.0 75,379.0 85,651.0 12.9 102,853.7 113,139.1 121,171.9 12.3
EBITDA 16,694.0 19,481.5 20,041.0 14.2 22,319.2 24,720.9 26,779.0 10.1
Margins (%) 23.6 25.8 23.4 - 21.7 21.9 22.1 -
Net Profit 11,062.0 12,434.5 13,516.0 9.8 14,534.7 16,051.9 17,320.4 8.6
EPS (|) 40.8 45.8 49.8 - 53.6 59.2 63.9 -
P/E 25.9 23.0 21.2 - 19.7 17.8 16.5 -
RoNW (%) 21.6 20.8 21.8 - 22.2 23.3 23.9 -
RoCE (%) 23.0 23.5 24.2 - 26.2 27.7 29.0 -
Source: Company, ICICI Direct Research

Key takeaways of recent quarter & conference call highlights

  • Reported term: The company reported rupee revenues of | 26,700 crore, up 8.2% QoQ & 19.6% YoY while dollar revenues came in at US$3,244 million (mn), up 5.3% QoQ, 9% YoY due to strong growth in P&P business. IT business reported revenue of US$2,326 mn, up 2.5% QoQ while ER&D business reported revenues of US$539 mn, up 2.8% QoQ. P&P in its seasonally strong quarter posted   a revenue of US$399 mn, up 32.1% QoQ

 

  • In CC terms: The company reported growth 5% QoQ revenue growth despite the impact of furloughs. IT business impacted by furloughs reported 2.1% QoQ growth while ER&D grew by 2.5% QoQ. The revenue growth at the company level was aided by P&P business which grew by 30.5% QoQ

 

  • Revenue Guidance: Due to the furlough impact on the IT services business & normalization of P&P business in Q4 the company has cut the upper end of the revenue guidance to 13.5-14% CC growth for FY23 at the company level & 16-16.5% CC growth for IT services business           

 

  • Margin Guidance: The company cut the upper end of the margin guidance by 50 bps to 18-18.5%. HCLT indicated that margin levers for improvement are pyramid optimisation by fresher deployment, easing of supply side pressure & lower attrition, offshoring & improvement in realisations

 

  • Vertical wise, in CC terms, growth was led by manufacturing, Lifesciences & TMPE reporting growth of 4.9%, 5.5% & 4.5%, respectively, while financial services, technology & retail were laggards with growth of -1.7%, 0.1% & -0.6%, respectively. The company indicated that financial services & technology vertical were impacted by furloughs while retail was down due to rampdown by a large client. The company indicated financial services will rebound in the next quarter on the back of deals won in the previous quarters and though in tech vertical furloughs were unexpected it sees opportunity on the back of vendor consolidation opportunities and increased in offshoring by clients

 

  • Geography wise in CC terms Europe reported growth of 7.2% QoQ while America region (64% of mix) reported flattish growth of 0.5% QoQ. The company indicated that America region growth was impacted by higher-than-expected furloughs

 

  • At the company level, EBIT margin increased ~160 bps QoQ to 19.6% while IT services margin increased ~10 bps. The company indicated the following were the levers for margin improvement at company level: i) +160 bps impact of increased P&P business, ii) +40 bps due to pyramid optimisation gains, iii) +30 bps due to improved realisations & iv) +70 bps due to currency benefit offset by the headwinds of -70 bps impact of wage hikes & -60 bps impact of furloughs

 

  • The company had indicated that it aspires to win TCV of US$2-2.5 bn every quarter. It delivered it by reporting TCV of US$2.3 billion (bn), down 1.6%QoQ & 9.9% YoY. The company also mentioned that it won 17 large deals in the quarter of which seven were in IT Services & 10 in P&P

 

  • HCLT net addition for the quarter was soft with addition of 2,945 employees taking its overall employee headcount to 222,270. The company during the quarter hired 5,800 freshers in Q3 taking the total fresher hiring to ~22,000 till YTD December 2022. The company had guided that it will hire at the lower end of 30,000-35,000 fresher in FY23. It, however, now has indicated that the fresher hiring during the year may be lower than it planned as supply side pressure is easing indicating moderate hiring in Q4FY23
 
  • LTM attrition of the company declined 210 bps QoQ to 21.7% and indicated that attrition will moderate further
 
  • The company mentioned that they are seeing vendor consolidation and cost optimisation opportunities ahead, which are now part of their pipeline. HCL Tech said they are incrementally seeing a trend of more cost optimisation deals and, hence, expects future deal pipelines to be skewed towards more cost take out deals. The company is also witnessing a similar trend in the unqualified pipeline and as in when it qualifies, it is likely to take up these opportunities and these opportunities are likely come up somewhere in Q2FY24 or Q3FY24. The company continues to target Global 2000 clients for their growth. HCL Tech also mentioned they continue to aspire preferred IT vendor across the existing clients on basis of end-to-end capabilities and offerings in cloud adoption, data engineering, digital workplace etc. The company added seven new global 2000 clients during the quarter. HCL Tech also indicated that lift and shift is not a bigger opportunity as it is largely applicable for companies with ageing IT landscape while application modernisation and architecture re-designing likely to bring in growth
 
  • The company said that vendor consolidation is one of the growth opportunities ahead. The company indicated that vendor consolidation opportunity could be around US$115 bn spread over next two to three years. The company indicated that vendor consolidation opportunities are emerging on account of i) clients are now looking for vendors who can offer them end to end capabilities and scale up digital transformation ii) some of the vendors are on weak financial muscle and iii) some architectural change for which clients are looking to source various stacks from the one vendor

 

  • The company indicated that large deal TCV for the quarter also includes three large deals of TCV US$1 bn. The company also clarified that cost take out program is not a part of this TCV number. The company mentioned that out of these three deals, one deal represents the opportunity wherein client is looking to change overall IT model for the organisation while second deal represents opportunity in vendor consolidation where the company is getting a lion’s share. In the third deal, the company is likely to replace struggling existing vendor. The company also mentioned that out of 17 large deals it won during the quarter, two are from BFSI space (one of the deals has TCV around US$500)

 

  • The company indicated that IT services revenue growth in Q3 was impacted by higher than expected furloughs. However, they expect some recovery in Q4. HCL Tech indicated that the near to medium outlook remains strong on strong deal wins. The company also indicated that deal win numbers are likely to remain in the band of US$2-2.5 bn in the medium term, which is likely to provide revenue visibility. HCL Tech also mentioned that retail vertical growth in the quarter was also impacted due to stress visible in some clients and ramp down from one client. The company also indicated that furloughs in Telecom & Media also impacted growth for the quarter, which was not the case historically. HCL Tech also mentioned that growth in the Europe vertical was not visible despite strong execution on one of the deals in telecom space there due to significant ramp down from another client in the telecom space there. The company, however, expects the recovery of the same in a couple of quarters, which is expected to drive the growth of the Europe region

 

  • The company mentioned that it aspires to reach 19-20% EBIT margin band in the near to medium term. Some of the levers for the same could be easing of supply side pressure, pyramid optimisation while it called out ‘utilisation improvement’ to be one of the biggest levers for margin expansion. The company also mentioned that pricing is stable in the market and new deals are coming at the higher pricing. It could be one of the levers for margin expansion in the medium to long term
 
  • The company also mentioned that revenue growth in Q4 is likely to be weak due to seasonally weak quarter for P&P business. HCL Tech also won large 26 deals in P&P business during the quarter but also mentioned that deal wins in the P&P business are not moving the needle in revenues as deal wins in this business are relatively small in the range of US$100K to US$10 mn

 

  • The company declared an interim dividend of | 10 per share
 
Variance Analysis
 
   Q3FY23   Q3FY23E   Q3FY22   YoY (%)   Q2FY23   QoQ (%)  Comments
Revenue 26,700 26,204 22,331 19.6 24,686 8.2 Reported 5% QoQ CC growth aided by P&P segment posting growth of 30.5% QoQ. IT services reported growth OF 2.1% QoQ due to higher impact of furloughs
Cost of sales (including 17,135 17,190 14,309 19.7 16,236 5.5  
employee expenses)              
Gross Margin 9,565 9,014 8,022 19.2 8,450 13.2  
Gross margin (%) 35.8 34.4 35.9 -10 bps 34.2 159 bps  
Selling & marketing costs 3,200 3,197 2,780 15.1 3,024 5.8  
               
EBITDA 6,365 5,817 5,242 21.4 5,426 17.3  
EBITDA Margin (%) 23.8 22.2 23.5 36 bps 22.0 186 bps  
Depreciation 1,136 1,048 991 14.6 998 13.8  
EBIT 5,229 4,769 4,251 23.0 4,428 18.1  
EBIT Margin (%) 19.6 18.2 19.0 55 bps 17.9 165 bps EBIT margin for IT services was up ~10 bps QoQ while at company level the margin improvement levers were : i) +160 bps impact of increased P&P business, ii) +40 bps due to pyramid optimisation gains, iii) +30 bps due to improved realisations & iv) +70 bps due to currency benefit offset by the headwinds of -70 bps impact of wage hikes & -60 bps impact of furloughs
Other income 144 170 203 -29.1 157 -8.3  
PBT 5,373 4,939 4,454 20.6 4,585 17.2  
Tax paid 1,276 1,185 997 28.0 1,096 16.4  
PAT 4,096 3,754 3,443 19.0 3,490 17.4  

Disclaimer

ANALYST CERTIFICATION

I/We, Sameer Pardikar, MBA, Sujay Chavan, MMS, Research Analysts, authors and the names subscribed to this report, hereby certify that all of the views expressed in this research report accurately reflect our views about the subject issuer(s) or securities. We also certify that no part of our compensation was, is, or will be directly or indirectly related to the specific recommendation(s) or view(s) in this report. It is also confirmed that above mentioned Analysts of this report have not received any compensation from the companies mentioned in the report in the preceding twelve months and do not serve as an officer, director or employee of the companies mentioned in the report.

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Buy: >15%

Hold: -5%to 15%;

Reduce: -15% to -5%;

Sell: <-15% 

Pankaj Pandey

Head – Research

pankaj.pandey@icicisecurities.com

 

 

ICICI Direct Research Desk,

ICICI Securities Limited,

1st Floor, Akruti Trade Centre,

Road No 7, MIDC,

Andheri (East)

Mumbai – 400 093

 

 

research@icicidirect.com
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