HCL Technologies' Q3FY18 results (Neutral) - Story lies beyond the headline numbers
Q3FY18 result highlights
- Headline numbers steady: Revenues grew by 3.1% qoq to US$1,987m (IDFCe: US$1,965m) and 3.3% in constant currency(CC) terms. EBIT margin were inline at 19.6%. EPS grew by 0.5% qoq and 7.5% yoy to Rs15.76 (IDFCe: Rs15.4) partially aided by lower tax rate.
- Looking beyond the headline numbers: While headline numbers are steady, we note that quality of earnings and internals seem weak. IMS (36.7% of revenues) de-grew 1.2% qoq CC, and grew only 1.6% yoy CC. Additionally, margins in IMS dropped 170bps qoq to 18.3%. HCLT was FCF (CFO-Capex) negative for the quarter.
- IP investment 20% of capital employed: HCL Tech continues to invest cash for IP partnership. The company invested another ~US$300mn in the quarter and has so far invested ~US$1.1bn. The IP investents are now at 20% of total capital employed. While we understand the need to rebuild growth engine amidst slowing IMS growth, we think clarity on growth and ROCE potential of this capital employed is limited.
- Guidance retained, likely to meet lower end for FY18: Management retained their FY18 US$ revenue guidance of 12.1%-14.1%, implying 1.5% qoq in Q4 to achieve the bottom end. Even EBIT margin guidance was retained at 19.5%-20.5% for FY18.
Key positives: Performance in engginerring and R&D
Key negatives: Weak IMS performance on both revenue and margins
Impact on financials: FY18E EPS revised up by 0.8%. EPS for FY19-20E revised up by 0.5%.
Valuations & view
Our cautious stance on HCLT is premised on slowing growth in IMS and need for P&L investments in IP partnership, which together will weigh on growth and margins. The risks on margins and limited clarity on return potential of IP partnerships will restrict any sizeable multiple re-rating from current levels (15x FY19E P/E). Our estimates remain below consensus and we expect 4.1% EPS CAGR for FY18E-20E despite ~9% revenue CAGR. We retain our March 2019 target price of Rs925 with Neutral rating.
HCL Technologies is a global IT services company working with clients in the areas that impact and redefine the core of their businesses. Co. focuses on 'transformational outsourcing', underlined by innovation and value creation, offering an integrated portfolio of services including software-led IT solutions, remote infrastructure management, engineering and R&D services and Business services. Co. leverages its extensive global offshore infrastructure and network of offices in 31 countries to provide holistic, multi-service delivery in key industry verticals including Financial Services, Manufacturing, Consumer Services, Public Services and Healthcare & Life sciences.
IDFC Securities Ltd., a subsidiary of the Infrastructure Development Finance Company (IDFC) wherein the Government of India holds a 20% interest, is India's leading equities broker catering to most of the prominent financial institutions, both foreign and domestic investing in Indian equities. A research team of experienced and dedicated experts ensures the flow of critically investigated stock ideas and portfolio strategies for our clients. Our coverage spans across various growth sectors such as agriculture, automobiles, Consumer Goods, Technology, Healthcare, Infrastructure, Media, Power, Real Estate, Telecom, Capital Goods, Logistics, Cement amongst other sectors. Our clients value us for our strong research-led investment ideas, superior client servicing track record and exceptional execution skills.
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