HCL Tech: Should investors buy in the fall?

Client-specific issue seems a one-off, recovery should start after September quarter, say analysts

HCL Technologies' stock tanked 12.65 per cent to Rs 857.9 on Thursday, as the company warned of tepid growth in the September 2015 quarter due to adverse currency impact, a client-specific issue and skewness in revenue growth due to transition timelines, especially in its IMS business. The move to reserve $20 million revenue is due to differences with one specific client but HCL might also see 80 basis points cross-currency revenue hit in the said quarter. These will in turn impact earnings. Analysts now expect the company's dollar revenues as well as net profit (in rupee  terms) to grow one per cent each on a sequential basis in the September quarter as compared to a little over 3 per cent projected prior to the news.

HCL's revenue growth is likely to be volatile going ahead. This is because the management is witnessing elongation in revenue recognition in its infrastructure management services (IMS) business due to complex projects. Notably, IMS forms about 35 per cent of its consolidated revenues. Increasing competitive intensity in this segment is another factor leading to slower revenue growth in the IMS segment, believe analysts.

The silver lining though comes from the possibility of large deal wins and market share gains in the IMS business in the medium-term. This is a key reason behind analysts' continued optimism on HCL Tech.

“Though we are not concerned about the currency impact, we are keen to gain more clarity on the client-specific issue and complexities in IMS business issues. We will wait for Q1FY16 numbers to alter our estimates. We maintain ‘buy’ with a target price of Rs 1,030,” said Edelweiss analysts.

Sandeep Muthangi, IT analyst at IIFL, sounds more positive. "We continue to be positive on HCL Technologies due to its high exposure to fast growing infrastructure services, improving traction in engineering services and cheaper valuations.”

Of the six analysts polled by Bloomberg on October 1 (post-HCL’s warning), three each have a ‘buy’ and ‘hold’ recommendations. Their average target price of Rs 996 implies an upside potential of 16 per cent from current levels.

The stock currently trades at 13.8 times FY17 revised earnings estimates, slightly higher than its historical one-year forward price/earnings of 12 times. Its closest peer, Wipro, on the other hand, trades at 14.5 times FY17 estimated earnings.

While HCL’s track record provides confidence and valuations appear inexpensive on a relative basis, the key lies in management commentary on demand trends, deals and outlook for IMS segment.