Friday, April 21, 2023

HCL Technologies Ltd; Slight Miss In Q4 Operating Performance; FY24 Guidance Better Than Expectations


CMP: Rs1038  

Target Price: Rs1150

HCLT delivered a tad weaker-than-expected operating performance in Q4FY23 due to weak discretionary spending. Revenue declined 1.2% CC QoQ, impacted by seasonality in Software (-14.6% CC QoQ) and decline in ER&D (-3.8%). Services revenue grew by 0.6% CC QoQ in Q4, led by Financial Services (6.9%), HLS (3.6%) and Retail and CPG (0.6%), while Telecom (-5.6%), Manufacturing (-3.5%) and Technology (-1.6%) remained weak. Net new deal intake remained healthy at USD2.07bn in Q4, led by operating model transformation, cloud adoption and vendor-consolidation deals across Financial Services, Manufacturing and HLS. HCLT has guided 6-8% CC revenue growth for FY24 (implied CQGR of 1.4-2.1% over Q1-Q4) and EBITM of 18-19%. Management has guided for 6.5-8.5% growth in Services business in FY24, implying 1.4-2.2% CQGR over the next four quarters. It observed project cancellations and delays in decision-making/ramp-ups in discretionary spending, while RTB spending has not seen much stress. HCLT is well-positioned to weather the storm, given its comprehensive service offerings and well-balanced portfolio across RTB and discretionary spends. We have cut our earnings estimates by 1.9-2.8% for FY24E/25E, factoring in Q4 miss and higher ETR. We maintain our BUY rating with a TP of Rs1,150/share at 17x Mar-25E EPS (earlier 1,160).

Results summary: Revenue declined by 0.3% QoQ to USD3.24bn (-1.2% QoQ/+10.5% YoY CC), below our estimate of USD3.27bn. EBITM fell by ~150bps QoQ to 18.1% on account of seasonality in the software business (-120bps) and a dip in services margin (-30bps). The services business’s EBITM declined by ~30bps QoQ to 17.4% due to decline in ER&D margin (-50bps), partially negated by efficiencies in the IT business (+20bps). Net profit stood at Rs39.8bn, higher than our estimate, due to higher other income and lower ETR. HCLT signed 10 large services deals and three software deals with a total new deal TCV of USD2.07bn in Q4. Financial Services grew by 6.9% CC QoQ on account of large deals ramp-up and strong demand for IT modernization and cloud. Manufacturing performance was subdued (-3.5%) due to the completion of projects. What we liked: Strong growth in Financial Services and America, better-than-expected guidance, healthy deal intake, moderation in attrition and healthy cash generation (OCF/EBITDA at ~130% in Q4). What we did not like: Weakness in ER&D and softness in manufacturing, tech and telecom.

Earnings call KTAs: 1) ER&D revenue declined in Q4 primarily on account of cut in discretionary spending and delay in deal ramp-ups in telecom and hi-tech verticals. 2) Net new deal intake remained healthy and well diversified across geographies and verticals at USD2.07bn, up 6.6% YoY (ACV up 4.3%). 3) Software business’s ARR crossed USD1bn, 5.2% CC YoY. 4) The company highlighted that its exposure to low-rated/troubled banks is <1% of its Financial Services’ revenue. The Financial Services vertical continues to have a promising outlook with capital markets and insurance driving growth. 5) Performance in Europe was weak due to slower decision-making and lower bookings. Management expects Europe to grow at a slower pace than the U.S. in the near term. 6) FY24 EBITM guidance remained lower than pre-Covid margin range, considering the exit quarter’s margin, macro uncertainties and likely business mix. Management aspires to return to the 19-20% EBITM trajectory. 7) Fresher intake stood at a record high of 26,734 in FY23 compared to 22,859 in FY22. HCLT plans to add 15,000 freshers in FY24. 8) IT services’ LTM attrition moderated to 19.5% in Q4FY23 vs. 21.7% in Q3FY23. Management indicated that quarterly annualized attrition has moderated to almost half in Q4FY23 compared to Q1FY23. 9) ETR is expected to increase to 25.5-26.5% for FY24 due to some units seeing movement across SEZ tax slab benefits; however, cash tax outgo is expected to be 5% lower.

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