HCL Tech stock: Brokerages believe correction offers attractive entry point

Brokerages believe correction offers attractive entry point

The HCL Technologies stock is down 12 per cent over the past couple of trading sessions on muted March quarter results and weak forecast, which has prompted revision in revenue estimates for 2018-19. While the immediate trigger was the sub-par performance in the quarter as the company posted a 1.2 per cent revenue growth on a constant currency basis (50-60 basis points lower than analyst estimates), the disappointment on account of growth outlook was the key worry.

The company has guided for a 9.5-11.5 per cent constant currency revenue growth, which will be split equally between inorganic and organic growth. While the organic growth is expected to be in the 4.25-6.25 per cent band, the inorganic portion includes growth from new acquisitions. The organic growth is lower than peers that are expected to post 7-8 per cent on this parameter. Analysts at Edelweiss Securities say the weak organic guidance despite strong digital, IP-related and product business growth (Mode 2 and 3), which are up 41.5 per cent in 2017-18, implies a leaking bucket of traditional services which have not been fixed.

This is inspite of global recovery, expected turnaround in infrastructure management services (IMS), and sustenance of momentum in product engineering space. This implies a big dent in either large clients or legacy services. The traditional (legacy services or Mode 1) is the applications infrastructure and business services accounting for 76 per cent of revenues. It grew at 5.7 per cent as compared to the faster growing Mode 2 and 3 segments, which grew 29-68 per cent.

 

Despite the weak revenue guidance, stable margin guidance of 19.5-20.5 per cent is positive as some of the acquisitions have sub-par margins. The improving trend in IMS is another positive. The segment recovered in the March quarter to record a sequential growth of 2.5 per cent, the highest in six quarters. The business is expected to rebound in the first half of the current financial year, based on recent deal contracts. The segment, which accounts for 37 per cent of revenues, has been struggling over the past seven quarters given the higher exposure to data centre management, cloud adoption, and automation initiatives.

The other key area the Street will keep an eye out for is the engineering and research and development (R&D) services which posted 1.7 per cent growth on a sequential basis (quarter-on-quarter). The company has underperformed some of its smaller peers with the transition to captive centres being a major threat.
 

While there are headwinds, after Thursday's fall the stock, according to analysts, is trading at attractive levels of 13 times its 2019-20 earnings estimates. Given the current levels, improving deal pipeline, and contract sizes, most analysts believe the stock is available at attractive valuations.