Q2 revenue recovery, valuations may sustain rally for HCL Tech

The stock has been underperforming peers after two consecutive quarters of muted revenue growth

HCL Technologies (HCL Tech) has gained 12 per cent over the last month on expectations of a recovery in revenue growth led by strong demand outlook and robust deal pipeline. Moreover, given the lower financial performance recently vis-a-vis peers, valuations too are at attractive levels.

HCL Tech is among the cheapest large and midcap IT stocks with valuations at 22 times its FY23 earnings estimates. Over the last six months, the stock has underperformed the Nifty IT index with returns of 28 per cent as compared to the 38 per cent returns of the index.

The reason for the underperformance has been two consecutive quarters of muted results. In fact, HCL Technologies is the only company in the Tier-1 software pack not to see an earnings upgrade for FY22. While Wipro and Tech Mahindra saw double digit upgrades while Infosys and TCS got single digit revisions, analysts revised HCL Technologies earnings estimates downwards by 1.3 per cent.

This however could change as the company has guided for a strong recovery in the September quarter. Acceleration of revenue growth from Q2FY22 is expected given higher demand for Cloud, infrastructure management, record high bookings and strong deal pipeline, say analysts at Sharekhan citing the HCL Tech management.

The extent of exposure to various verticals could also aid the company. Analysts at Motilal Oswal Research believe that HCL Tech’s exposure to deeply troubled verticals such as energy, travel, retail among others is lower than peers while higher contribution from financials, technology and life sciences is positive given a better outlook for these verticals.

Further, higher exposure to infrastructure management (37 per cent of revenues) comprising a larger share of non-discretionary spends offers better resilience to portfolio in the current context with increased demand for cloud, network, security and digital workplace services.

In addition to revenue growth, recovery in margins (prior to interest and taxes) which came in below expectations at 19.6 per cent in the June quarter would be another trigger. Margins were down 70-90 basis points on sequential and year ago levels. The extent of the gains would also be dependent on the recovery in engineering, research and development vertical which fetches higher margins. The company expects margins to improve after a couple of quarters of investments and has maintained its guidance at 19-21 per cent.