HCL Technologies: Soft power

While there has been a lot of noise around the new US President’s efforts to make H-1B visa norms stricter, the large-cap IT stocks which are trading at relatively inexpensive valuations are good buys now for long-term investors.

Over the last couple of years, Indian IT service majors have been preparing for tighter US immigration norms. In this context, HCL Technologies is at an advantage as half the workforce deployed in US projects are locals.

Among the large-cap IT companies, HCL Technologiesseems a good buy now. The company’s revenue and profits have grown better than peers over the last two quarters. Large deal wins across service lines and verticals, and continuous improvement in margins are positives.

Also, even as Infosys and others have revised their full-year (2016-17) revenue guidance downwards, HCL Technologies continues to keep it at 12-14 per cent on constant currency terms for 2016-17.

Further, with strong capabilities in the Infrastructure Management Services and engineering space, where demand is strong, revenue visibility looks good for the company. Focus on building the IP (Intellectual Property) capabilities through partnerships should also buttress growth. At the current price of Rs 838, the stock discounts its estimated earnings for 2017-18 by 13 times. In the last three years, the stock has traded in the band of 13-18 times.

In the December quarter, HCL Technologies reported revenue growth of 13.8 per cent in constant currency terms over the same period last year. This was up from 12.8 per cent in the September quarter and 11.2 per cent in the June quarter.

HCL has been reporting large deal wins over the last year, which appears to have added to the revenues in recent quarters. On sequential terms, revenue growth in the December quarter was 3 per cent (in constant currency terms) — the highest among the large-cap peers.

Revenue growth was strong across verticals and service lines. The engineering services business grew 7.1 per cent, the infrastructure services business (40 per cent contribution to revenue) grew 2.1 per cent — not a bad show given that it had registered growth of 4.4 per cent in the September quarter and 16.5 per cent in the June quarter — and application services business grew 2 per cent. The BPO business recorded a 2.9 per cent growth.

Among verticals, the financial services segment recorded sequential growth of 4.5 per cent, manufacturing grew 8.3 per cent and the public services segment (that includes energy, travel and logistics)5.6 per cent.

New clients contributed to 6.8 per cent of total revenue in the December quarter, up from 4 per cent last year. The number of clients in the $100-million-plus bucket stood at eight, up from seven last year.

Clients in the $50-million-plus bucket numbered 24, up from 19 in December 2015.

There has been increase in efficiency in client mining too. Revenue from top-five clients contributed to 14.2 per cent of overall revenue in the recent December quarter, increasing from 13.6 per cent in the same quarter last year. HCL has given a revenue guidance of 12-14 per cent for the full year (2016-17), but actual growth may be higher as the guidance does not include contributions from Geometric and IP-led partnerships which will be integrated with the company from the March quarter.

Over the next one-two years, HCL may see a stronger revenue growth than peers. The company has been collaborating with global tech giant IBM to develop product platforms.

Last September, it announced a 15-year partnership with IBM to develop features on a few of the latter’s existing platforms.

The total investment in this partnership was stated as $155 million, which may yield about $40-45 million in revenue in the first year, according to the company. Revenue growth will be buttressed by contributions from the products business. This source of income will not face risk of price pressure.

The company’s operating margin was 22.2 per cent in the December quarter, up from 21.8 per cent in the September quarter and 21.5 per cent in the same quarter last year.

Margins were helped by higher contribution from fixed price contracts and automation-led benefits.

Fixed price contracts contributed to 63.2 per cent of revenue in the December quarter, up from 57 per cent in the same quarter last year. DRYiCE — the company’s IT automation platform — is also helping save costs.

Over the next year, increase in contributions from the IP partnerships will aid profit margins.

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