HCL Technologies' Q4FY18 results (Neutral) - Weak organic growth and soft commentary

Q4FY18 result highlights

• Inline quarter: Revenues at US$ 2038m, up 2.5% qoq (IDFCe: US$2038m). CC revenues grew 1.2% qoq was tad below estimates (IDFCe: 1.3% qoq). EBIT at Rs25.8bn was again inline with estimates (IDFCe:Rs25.7bn) as EBIT margins came inline with estimates at 19.5%. PAT was at Rs22.2bn up 1.5% qoq vs. IDFCe of Rs22.3bn.
• IP investment strategy to continue: HCL Tech continues to invest cash for IP partnerships. There was no IP investment in this quarter, but the managnment indicated that they will continue to build on the IP portfolio. The IP investents are now at 20% of total capital employed
• Weak organic revenue guidance: HCLT has guided for CC revenue growth of 9.5%-11.5% in FY19. This included recently announced acquistions (+4%) and  even unannounced acqusitions (+1.25%). The implied organic growth guidance at 4.25%-6.25% is weak and sizeably below peers. Management indicated renewal compression is driving weak organic outlook.
• Flat margin guidance with a weaker INR assumption: EBIT margin guidance was at 19.5%-20.5% for FY19. This effectively implies a drop in CC margins given this assumes USDINR realisation of 66 vs. FY18 64.5. This coupled with higher proportion of IP revenues and Actian acqustion (36% EBITDA margin), should have actually been margin accretive. 

Key positives: Pick up in IMS growth in this quarter

Key negatives: Weak guidance and outlook

Impact on financials: EPS for FY19E/20E unchanged.

Valuations & view

Our cautious stance on HCLT has been premised on cannibalisation of IMS, slowing organic growth and need for P&L investments in IP partnership, which together will weigh on growth and margins. These risks on margins and growth are beginning to play out. We think that weak organic growth will weigh on multiples. Our estimates are unchanged and remain below consensus. We maintain our March 2019 target price of Rs925 (set at 13.7x FY20E P/E) with a Neutral rating.