HCL Technologies' Q2FY19 results (Neutral) - Revenue performance steady; keep the focus on cash flows

Q2FY19 result highlights

• Revenues tad better estimates: US$ revenues at 2099m, up2.1% qoq (IDFCe: US$2084m). CC revenues grew 3% qoq was tad above our  estimates (IDFCe: 2.5% qoq). Organic revenue growth was areound ~1%.EBIT at Rs29.6bn below our estimates of (IDFCe:Rs30.4bn) as EBIT margins came below  our  estimates at 20%(IDFCe: 20.9%). Mode 2 (16% of revenues) EBIT margins declined 400bps QoQ to 10.8%. PAT was at Rs25.4 bn up 5.7% qoq vs. IDFCe of Rs26.2 bn.
• IP investments continue: HCL Tech continues to invest cash for IP partnerships. Management mentioned that they will continue to invest in inorganic investments. Net intangible assets stood at US$1.22bn for the quarter.
• CC guidance retained: HCLT has guided for CC revenue growth of 9.5%-11.5% in FY19 - unchanged. The USD revenue growth guidance is cut by 20bps (factor in cross currency). EBIT margin guidance is retained inspite of weak INR.
• Operating cash flow growth tepid: Operating cash flow growth is our favoured metric for HCLT, and this remained weak in Q2. US$-CFO was weak at US$277.6m (CFO/EBITDA – 56%), up only 5% YoY even as reported US$-EBITDA was up 15.1% YoY. 1HFY19  US$-CFO declined 5% YoY vs. US$-EBITDA growth of 15% YoY In the quarter HCLT had a cash outflow of US$65mn towards IP and US$306m related to acquisitions. FCF was negative US$367m this quarter.  

Key positives: IMS back to growth

Key negatives: Mode 2 margins and operating cash flow

Impact on financials: EPS unchanged for FY19E/FY20E/FY21E.

Valuations & view

Our cautious stance on HCLT has been premised on cannibalisation of traditional business and acquisition heavy model of growth. While P&L performance continues to hold up well, we see weakness in cash flow performance and subdued organic revenue growth We maintain our Dec 2019 target price of Rs1075 with a Neutral rating.