MOSL: HCL TECHNOLOGIES (Neutral)-Core growth slowing down-while focus on Products accelerates

HCL Technologies: Core growth slowing down; while focus on Products accelerates

(HCLT IN, Mkt Cap USD21.4b, CMP INR958, TP INR950, 1% Downside, Neutral)

•  3Q above estimates: HCLT’s 3QFY18 CC growth of 3.3% QoQ was above our estimate of +2%. The beat seemed to be a function of seasonal strength in Products. Growth in the core services of Application Services (1.6% QoQ CC) and IMS (-1.2% QoQ CC) clearly did not contribute to the strength. The underlying weakness (also due to India ramp-down and DXC headwinds) is reflected in expectations of HCLT meeting the lower end of its 10.5-12.5% YoY CC growth guidance.
• Impact of amortization aggravating: EBIT margin contracted 10bp QoQ to 19.6%, while EBITDA margin expanded 90bp QoQ. Depreciation and amortization expense increased by 100bp; HCLT’s amortization schedule suggests an increase of USD30m for each of the next four years. PAT increased 0.3% QoQ to INR21.9b, above our estimate of INR20.6b, driven by the slight operational beat and higher other income.
• Slowing Mode-1; Aggression on Mode-3: YoY CC growth in IMS plummeted to 1.6%, partly because of the India ramp-down. Although this is expected to see better days, a shade of caution was witnessed in the outlook, as data center revenue (50% of IMS) has been facing headwinds because of cloud migration and automation. On the other hand, ~USD1b investments in IP partnerships over the last two years are just the beginning of HCLT’s products journey, where aspirations of organically building presence in the entire product lifecycle will be aggressively pursued.