Despite immediate challenges, HCL Tech a good bet for long-term investors

HCL Technologies has lagged its peers on concerns over organic growth and near-term profitability. The stock has shed about 4 per cent in the last three months, compared to a 0.5 per cent gain for the Nifty IT index. 

Valuations, too, are at a 22-45 per cent discount to IT peers, and this is unlikely to improve soon. 

Investments made for new deal wins and additional fixed costs for its recently concluded IBM deal will weigh on near-term profitability and earnings. The management, too, had cut its FY20 margin guidance by 100 bps to the 18.5-19.5 per cent range (lower than 21-23 per cent guided by peers like Infosys) during the Q4 earnings. 

Notably, these company-specific events add to the margin pressure that the sector is facing, which include unfavourable currency movement, a tighter H1B visa regime, and other talent-related issues.

Though strong deal wins (up 24 per cent in FY19) at 78 and the IBM deal improves top line growth potential, the expected benefits could get negated, given the global slowdown.

Analysts believe that with the dismal global macro situation, IT customers may hold back on deal execution, hurting conversion of deal wins to revenues for the sector. For HCL, this could cap organic revenue growth and, consequently, valuations. 

Though Accenture reported strong spending in the North American regions last week, it was driven by the Federal government, which the Indian players do not address materially, showed a report by Nirmal Bang Research.

According to Aniket Pande, analyst at Prabhudas Lilladher, unless organic revenues rise sharply, HCL’s valuations are unlikely to improve materially. The expected 8-9 per cent organic revenue growth in FY20 could give a marginal push to valuation to 13-14 times, he added.  Analysts do not see re-rating of the stock anytime soon, unless there is consistency in revenue growth and margins. 

However, once the macro situation improves and the IBM deal delivers on growth and margins, HCL Tech could be a good bet. Current valuations, thus, offer favourable risk-reward to long-term investors.