Valuation discount brings more comfort to HCL Technologies' investors

FY21 growth outperformance could be a challenge

A better-than-expected performance on revenue and margins in the December quarter as well as a guidance revision should help HCL Technologies report the best organic growth among large-cap peers in 2019-20 (FY20).

The company revised its revenue guidance in constant currency terms for the current financial year to 16.5-17 per cent, from 15-17 per cent indicated earlier. This will translate into an organic growth of 10-11 per cent — the highest among large-cap companies.

Margin guidance, too, has been increased to 19-19.5 per cent, from 18.5-19.5 per cent. The margin revision comes on the back of second consecutive quarter of 20 per cent-plus operating profit margins. This was achieved on the back of higher productivity and a shift from lower margin products. Given the 310-basis point margin gains over the last couple of quarters, analysts expect the company to achieve the projected margin targets.  

The gains, both on the revenue as well as the margin fronts, were led by the products and platform business. On the revenue front, the overall sequential growth of 2.3 per cent was led by a 16.8-per cent growth in the products business, with IBM intellectual property business contributing to incremental revenues in the quarter. While a strong deal pipeline will have a positive bearing on the growth outlook, brokerages highlight some wrinkles.

Analysts at Phillip Capital believe the strong organic growth in FY20 is an outcome of a few large deals ramping up in the fourth quarter of 2018-19 (FY19) and the first quarter of FY20. This may not recur in 2020-21 (FY21).

Whether the company will be able to achieve $625-million revenue from the IBM deal in the first four quarters is still ambiguous. Unlike in FY19, the company has not won any $1 billion dollar-plus deals in FY20. This might impact the growth outlook for FY21. The management, however, indicated that renewals have been steady, pricing demands have moderated, and the deal pipeline has been the highest in recent quarters.

While there is lack of clarity on FY21 growth, what gives comfort are the valuations, which at 13.3x the FY21 estimates are at a 38 per cent discount to Tata Consultancy Services. This is higher than the five-year average. Given the target prices are upwards of Rs 650, there is an upside in the 10-20 per cent range from the current levels.