Nothing much to bridge HCL Tech’s valuation gap with peers
HCL Technologies Ltd’s products and platforms (P&P) vertical was a pain point in the quarter ending March (Q4FY22) with the segment’s revenues falling 24% sequentially. Still, aided by the IT services vertical, HCL’s overall revenue grew by 1.1% in constant currency terms. This measure stood at 3.2% and 1.2%, respectively for peers Tata Consultancy Services Ltd (TCS) and Infosys Ltd. For FY22 as well, HCL has underperformed these two on constant currency revenue growth and earnings before interest and tax (Ebit) margin.
For FY23, HCL has guided for 12-14% revenue growth and 18-20% Ebit margin. In comparison, Infosys’ constant currency revenue growth and operating margin guidance is 13-15% and 21-23%, respectively. TCS does not share any guidance.
IDBI Capital Markets and Securities expects the majority of HCL’s FY23 revenue to be driven by IT services, while P&P is likely to be subdued. So, IDBI foresees HCL witnessing revenue growth at the lower end of this guidance.
In a call, the HCL management said it expects P&P business to remain volatile in the near-term, as it is making efforts to push more product licences into becoming subscription-based. This may not bode well for the stock. HCL’s shares trade at 20x times its estimated FY23 earnings, a discount to TCS and Infosys’ 31x and 26x, respectively, according to Bloomberg data.
“We expect this valuation gap between HCL and these peers to continue, at least in the near-term,” said an analyst with a foreign brokerage house requesting anonymity. P&P is a high-margin generating business, but also seasonal and discretionary in nature, he said. “So, weak performance here means an additional drag for HCL at a time cost pressures are rising for the entire industry,” said the analyst.
Among the positives, HCL’s management has said that the deal pipeline remains strong across all regions and verticals. For FY22, the total contract value (TCV) of new deal wins rose 14% year-on-year (y-o-y) to $8,308 million. For Q4, HCL won 10 net new deals and the TCV of new deal wins rose 6% sequentially to $2,260 million.
Further, while the company expects attrition to be high in the near-term, it is on a hiring spree. Net additions were 11,100 globally in Q4 and 39,900 in FY22. Given the strong demand, HCL plans to increase fresh graduate hiring to 45,000.
Peers are also seeing good traction in deals and are hiring massively, so these developments are unlikely to help bridge the valuations gap. “While the stock is trading at 30% discount to peers, rerating would be contingent on a more consistent delivery on growth and margins,” said a report by IIFL Securities Ltd on 22 April.
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