Prabhudas Lilladher's report on HCL Technologies
HCL Technologies (HCLT) reported a comprehensive miss to PLe/Consensus’ expectation. The revenue growth momentum retracted to declaration after witnessing slight acceleration in the previous quarter. We continue to believe increased competition in IMS (peers & cloud), pressure on margin (investment and pricing), and mean reversion in FCF conversion, would weigh down on stock price in near term. We reiterate our cautious stance and revise TP to Rs970 (from Rs1,050).
Comprehensive miss to expectation: HCLT reported revenue growth of 0% QoQ (PLe.: 2.3%, Cons.: 1.4%). EBITDA margin eroded by 242bps to 22.6% (PLe: 24.7%, Cons.: 24.5%) due to investments and wage hike. Q3FY15 revenue growth (@cc) in slowest since Q3FY12, but strongest among peers. (Exhibit: 3)
Operating margin continues downward slide: In-line with our expectation, HCLT is witnessing pressure on margin on account of investments in business, and hiring workforce. We expect sustained pressure on margin as HCL Tech enters next phase of investments over next 12-18 months. (Exhibit: 4, 5, 6)
FCF conversion worsened to multi-year low: Our long standing hypothesis of balancing act of revenue growth, EBITDA margin and FCF conversion continue to play-out. HCLT enjoyed improved operating margin and FCF/EBITDA conversion over FY12-14 on account of under investment in the business. As HCL Tech gears up for the next leg of growth operating margin and FCF/EBITDA conversion dipped to the lowest, since Q3FY13 and Q2FY12 respectively. We expect operating margin and FCF conversion to stay subdued in CY15.(Exhibit: 7)
Is high exposure to IMS a risk?: IMS continues to be a growth driver for HCL Tech, but recent trends provide mixed read-thru for incumbents like HCL Tech: 1) Clients’ decision is not based only on pricing 2) Indian IT wins market share against Global MNC 3) Fresh pricing negotiation for deals signed in 2008-09.
We tweak our model for weaker growth and margin profile for FY15-17E.
Valuation & Recommendation – ‘Accumulate’, with revise TP of Rs970: "HCLT will grow in-line with industry with continued pressure on margin suppressing earnings momentum. We retain our “Accumulate” rating", says Prabhudas Lilladher research report.
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