HCL Technologies: Slow product sales may be near-term overhang

Overall growth is likely to remain strong

An 8 per cent decline in sales of the products and platforms segment played spoilsport in an otherwise strong September quarter (Q2FY22) for HCL Technologies. The sales decline was on account of a delay in deal closures, according to the management of India’s fourth-largest software services firm by market capitalisation.
 
The company reduced the FY22 growth guidance for the segment, which contributed 12 per cent to Q2 revenues from low single digits to a relatively flattish 0-1 per cent. While analysts expect the business to bounce back next year and register better numbers, there may be a near-term impact. 
 
Mukul Garg and Akshay Ramnani of Motilal Oswal Research view the guidance cut to be a drag on valuations in the near term due to elev­ated uncertainty in the business and relative lack of comfort in its business potential.
 
Barring this, there is little to complain about in the results. The two big chunks of its services business — IT services and engineering, research and development — reported better-than-expected revenue growth (5.2 per cent-5.4 per cent range). Further, the new deal momentum stayed strong at $2.2 billion — up 38 per cent over the year-ago quarter. New deals were aided by 14 new large deal wins.
 
The management confidence on the growth front is reflected in the overall guidance that remains at double-digit dollar revenue growth and the margin at the EBIT level (earnings before interest and taxes) of 19-21 per cent. The margin in Q2 was lower by 60 basis points on a sequential basis to 19 per cent, due to the decline in the contribution from the higher-margin products and platforms segment. The margin for the services business was flat on a sequential basis.
 
Analysts also highlight strong employee additions for the company. Net addition of 11,135 employees during the quarter is the highest in 24 quarters, according to analysts at Edelweiss Research, taking the total headcount to 187,000 employees. This should offset some pressure on account of attrition, which moved up to 15.7 per cent, against 11.8 per cent in the previous quarter.

 

Despite the products miss, given the strong overall guidance, deal wins and outlook for the services business, brokerages remain positive on the stock. Analysts at Edelweiss Research says: “We believe the deal slippages in the products and platforms business are one-time in nature while services business continues to report strong growth. The pipeline remains robust and strong employee addition will lead to accelerated implementation in the coming quarters.”
 
Valuation comfort is the other factor that should support the stock. At 22 times its FY23 earnings estimates, the stock is at a sharp discount not only to its larger peers (28-30 times P/E for Infosys, TCS and Wipro) but also to the top 15 mid-caps which trade in a much higher range. While the muted products showing may be an overhang, investors can use any correction to accumulate the stock for the long term.