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MOSL : HCL TECHNOLOGIES: Guidance increase may help drive stock rerating

.  HCL Technologies: Guidance increase may help drive stock rerating

(HCLT IN, Mkt Cap USD30.9b, CMP INR939, TP INR1240, 32% Upside, Buy)

Strong margin recovery to drive earnings outperformance

• HCLT delivered a strong revenue growth of 3.8% QoQ CC in 2QFY23 (100bp above our estimates), led by IT services & ER&D verticals. Overall services grew 5.3% in CC terms and it reported robust new deal TCV of USD2.4b (+16% QoQ/+6% YoY). The company increased its revenue guidance to 13.5-14.5% in CC terms from 12-14% earlier, which was a surprise, given the weakening macro environment.
• Further, it delivered a strong beat in EBIT margin at 18.0% (+100 bp QoQ, 70bp above MOFSLe) with IT services up 100bp QoQ, ER&D up 270bp QoQ, while P&P down 220bp QoQ. HCLT revised its EBIT margin guidance to 18-19% from 18-20%.
• Despite the tough demand environment, HCLT maintained its momentum by beating our expectations in both IT services and ER&D verticals. Moreover, the continued strong deal TCV (book to bill of 0.8x), pipeline commentary and revenue growth guidance of 16-17% YoY in CC terms for the vertical should reassure investor concerns on the company’s growth.
• The P&P vertical declined 7.8% QoQ on seasonality and the company expects it to remain flat for FY23 (we estimate mid-single digit CC decline). Though growth visibility remains low, we continue to see a good potential for it in the long run after flattish growth over FY22-24E.
• HCLT delivered an exceptional margin improvement in 2Q, delivering a large beat to broad expectation of miss to FY23 margin guidance. We expect HCLT to deliver FY23 margin at the lower end of its margin guidance, and further improve to 18.7% in FY24.
• This strong growth guidance and margin performance (despite wage hikes) in an environment, where the demand for IT services is expected to be incrementally weaker, should help improve investor confidence on its business and lower the valuation gap with larger Tier 1 IT services peers. We continue to see HCLT’s defensive business as a positive in a demand constrained environment.
• On a combined basis, HCLT is expected to deliver a USD revenue growth of 10% and corresponding PAT CAGR of 11.3% over FY22-24. HCLT is currently trading at an inexpensive 15x FY24.
• We increased our estimates for FY23 and FY24 by 4%-6%. We reiterate our Buy rating with a TP of INR1,240/share (20x FY24E EPS).