HCL Technologies: IT’s looking up

Among large IT companies, HCL Technologies (HCL) has almost always delivered growth rates that have been ahead of the industry. The company has been among the few in the domestic IT space to have consistently recorded double-digit revenue growth in dollar terms over the past several years.

The stock has corrected by nearly 15 per cent after its March quarter results were announced, as its revenue growth guidance for FY-19 disappointed the markets. A good part of its projected growth (9.5-11.5 per cent) is expected from the companies it acquired recently. But the correction may have been an overreaction, as the growth rates are still among the best in the industry.

Companies do need to take the inorganic route to grow and explore newer niche digital services areas and HCL has consciously made acquisitions that add to its offerings. To put HCL’s guidance in perspective, trade body Nasscom has projected a growth rate of 7-9 per cent for the IT industry in FY-19.

Strong expansion in revenues from digital offerings, healthy client additions and robust traction in key verticals such as financial services and manufacturing are positives for the company.

The fall in share price presents an even more attractive entry point for investors with a two-year horizon. At ₹915, the HCL stock trades at just 13 times its estimated per share earnings for FY-19, lower than peers such as Wipro and Tech Mahindra that trade at 15-17 times. This valuation discount does not appear justified, given that HCL has better operating margins and revenue growth rates compared to its peers. Even mid-tier IT players trade at much higher multiples.

In FY-18, HCL’s revenues increased by 8.2 per cent over the previous fiscal to ₹50,570 crore, while net profits rose by 3.8 per cent to ₹8,780 crore. In dollar terms, revenues increased by a healthy 12.4 per cent in 2017-18, which is the highest among top-tier IT players and also among the best in the industry.

Digital thrust

HCL classifies its service offering under three ‘modes’. Mode 1 is its traditional application and infrastructure services offering. Mode 2 refers to digital services, while mode 3 consists of products and platforms. The company has seen a massive ramp-up in revenues from mode 2 and mode 3 offerings.

HCL derived 23.4 per cent of its revenues from these modes in FY-18, up from 18.6 per cent in the previous fiscal. Revenues from both these modes are growing at a fast clip — mode 2 revenues rose by 29.4 per cent and mode 3 by 68.3 per cent in FY-18. Clearly, HCL has been able to tap into the digital spends of clients.

The company’s acquisition of Actian Corporation, through a joint venture with Sumeru Equity Partners, is expected to bolster its digital and cloud offerings.

The proportion of non-traditional revenues that HCL derives compares favourably with what other top-tier IT players have recorded.

 

Broad-based growth

Two of the HCL’s key verticals — financial services and manufacturing — which account for over 60 per cent of overall revenues have grown at 13.3 per cent and 18.3 per cent respectively in FY-18, higher than the overall company’s revenue rate.

Its engineering and R&D service line grew at a robust pace of 37.8 per cent during last fiscal. HCL’s key infrastructure management services offering, which had a few tepid quarters, has witnessed a revival in the March period.

Revenues from all its key geographies have expanded at a reasonable pace, with the US growing at a robust 13.8 per cent.

Clearly, the growth has been broad-based for the company, suggesting a fair degree of client traction. HCL added three customers in the $50-million category, six in the $40 million bucket and as many as 18 clients in the $10-30 million range. Thus, client addition appears quite robust for the company.

Operationally, many parameters are looking up for the company.

The company’s attrition rate has reduced from 16.9 per cent as of March 2017 to 15.5 per cent as of March 2018, thus lowering execution risks.

Utilisation for HCL was at 85.9 per cent in March 2018, which is among the highest in the industry, indicating optimal deployment of its workforce.

From a productivity standpoint, HCL’s revenue per employee, at $66,406 in FY-18, compares quite favourably with peers. The revenue per employee for Infosys is $54,600.

While acquisitions would drive growth in the near future, HCL’s core offerings, as seen from the above factors, appear to be on a revival path.

The stock may, thus, be a reasonable bet for long-term investors and those looking at defensives to hedge themselves during volatile times.

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