HCL Q2: Tepid show by infra, engineering verticals

Market shows disappointment with HCL Technologies’ Q2 performance

HCL Technologies disappointed investors with a sequential revenue growth of mere 0.9 per cent in the September quarter. Both Infosys and TCS had reported higher growth.

The stock closed in the red on Wednesday as investors felt let down by the poor show in key verticals — infrastructure and engineering services.

In infrastructure services, the company saw growth decline by 0.2 per cent sequentially in constant currency terms. In engineering services and Research and Development, revenue growth was 4.4 per cent, down from 7.9 per cent recorded in the June quarter.

But given that June 2017 was a strong quarter for the company when peers had returned a bad show, the under-performance in the September quarter can be forgiven.

The operating margin stood at 22.19 per cent, up 12 basis points over the June quarter and 39 basis points over the same quarter last year.

The stock of HCL Technologies has been an out-performer in the IT space over the past six months.

The stock’s valuation multiple has moved up from about 13 times (on estimated earnings of 2017-18) to 14.5 times now — at par with Infosys.

Over the next two quarters, the company has to ratchet up growth, else it may lose its premium valuation.

What gives some comfort is that the company has maintained its revenue guidance for the full year at 10.5-12.5 per cent, in constant currency terms.

The company’s confidence in achieving the revenue target seems to come from the acquisition of Geometric and contributions from IBM IP and Butler deals. On an organic basis, the company may achieve revenue growth of 5-6 per cent in the full year 2017-18.

Operating metrics

Some amount of the premium the stock enjoys is also because of its stable margins.

Even as its larger peers, Infosys and TCS, have seen operating profit margins decline in the last one year, it has been stable for HCL Technologies.

This is thanks to cost savings from the company’s automation platform, DRYiCE, and improved operational performance.

The firm has brought down attrition to 15.7 per cent in the recent September quarter from 18.6 per cent in the same quarter last year.

The utilisation rate including trainees stands at 86 per cent, up from 85.3 per cent a year ago.

But if growth or margins suffer as the company integrates the new acquisitions, it may hit the company’s market valuation.

Outlook

Investors with a stomach for risk can stay with the stock to see how the company manages its different metrics going ahead — if its aggression in acquisition helps it build strength in new areas and opens up areas for growth.

For instance, the company has acquired IP of mature products from IBM, which will be revived using HCL’s R&D skills.

These products can help the company achieve a higher growth.

The company is also aggressively going after its old clients to mine more business.

The top five clients contributed 15.1 per cent to the revenue in the recent September quarter, up from 13.8 per cent in the same quarter last year. Revenue from top-10 and top-20 clients have also increased.

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