HCL Technologies margins to moderate in H2FY21; investors remain cautious

US elections, a seasonally weak Q3, and sharp stock gains are weighing on return expectations

Despite a better-than-expected performance in the September quarter, the stock of HCL Technologies shed 4 per cent in trade on Friday. Moderating margins in the second half of FY21, a seasonally weak December quarter, and tempering of return expectations seem to be weighing on the stock. Prior to the correction, the stock, which is currently trading at Rs 827, had gained 43 per cent over the past three months to reach Rs 900 in October. 

While September quarter margin, before interest and taxes, was 21.6 per cent, the highest in over four years, the firm has guided for a full-year margin of 20-21 per cent. With margin in H1 exceeding 21 per cent, there may be some moderation on the back of pay hikes, rising headcount, and higher sales and general administration expenses —especially travel costs. 

Analysts say other headwinds could be in the form of pricing pressures in new contracts and discount pressures. The firm indicated that the December and March quarters may witness margin stability rather than sharp gains. 

However, an analyst at a domestic brokerage highlights that margin pressures would be offset by a higher share of digital services business, to an extent. The fast-growing digital or new services segment accounts for 21 per cent revenue and has a higher gross margin than the traditional legacy segment. Margin in the segment has risen 450 basis points year-on-year. 

On the revenue front, the firm posted 4.5 per cent constant currency sequential growth, which was better than the mid-quarter guidance of 3.5 per cent growth given a month earlier. Given the 1.5-2.5 per cent sequential growth for the December and March quarters, the firm could end up with 1 per cent growth for the year. Revenue growth, especially in the seasonally-weak December quarter, may moderate because of furloughs and lower manufacturing activity. Possibility of more lockdowns has also forced the firm to be cautious.

Brokerages, however, believe that the long-term growth trajectory is positive, given higher contract wins, a strong deal pipeline, market share gains because of vendor consolidation, increased offshoring and digital migration. 

While the immediate cause of the stock price correction has been sharp gains, investors are cautious, given uncertainty because of the US elections, and are looking for post-event stability before increasing exposure.