HCL Technologies Ltd - Stock Valuation and Financial Performance

Key Highlights – In-Line Performance

1. Segment Performance:

• IT & Business Services (73% of revenue): Grew 5.8% YoY CC (Constant Currency) and 1.5% QoQ CC, driven by demand in Retail and Tech & Services.

• Engineering & R&D (16% of revenue): Increased 1.1% YoY CC and 5.4% QoQ CC, aided by Manufacturing and Telecom, despite challenges in Automotive.

• HCL Software (11.3% of revenue): Grew 18.7% QoQ CC, but fell 2.1% YoY due to delays in renewals and deal closures.

2. Margins:

• EBIT Margin: At 19.5%, down 37 bps YoY, but up 90 bps QoQ, driven by a strong Software segment.

• Wage hikes, furloughs, and integration costs slightly impacted Services margins.

3. Regional & Sector Performance:

• Americas: Grew 6.2% YoY CC and 1.9% QoQ CC.

• Europe: Moderate growth at 2.6% YoY CC and 3.5% QoQ CC.

• Retail & CPG: Rose 13.7% QoQ CC, supported by project completions.

• Telecom & Media: Gained 4.0% QoQ CC, aided by the Hewlett Packard Enterprise acquisition.

• Automotive: Struggles persist; recovery expected in upcoming quarters.

4. Key Deal Wins:

• Total Contract Value: Secured $2.095 billion, up 8.7% YoY but down 5.5% QoQ, with smaller deals dominating.

• Major deals included AI automation for a Fortune 50 telecom firm and cloud migration for a leading US financial firm.

5. Workforce & Other Highlights:

• Headcount: Grew by 2,134, totaling 220,755 employees.

• Attrition: Edged up slightly to 13.2%.

• Demand across Retail, Manufacturing, and Telecom remains robust, though challenges persist in Life Sciences and Public Services.

Stock pulse is a format where we explore the most important questions to understand the company's performance.

About HCL Tech

HCL Tech is a leading global IT services company, ranked amongst the top five Indian IT services companies in terms of revenues. HCL Tech offers an integrated portfolio of services including software-led IT solutions, remote infrastructure management, engineering and R&D services, and BPO services.

Consolidated Revenue Mix:

(Source: Company data, Amt in Rs. Cr)

Segment EBIT Margins:

Engineering and R&D services (ER&D) are a high-margin business (18-22%) as against IT & business services (16-17%, FY21 margins were abnormal and do not show a true picture). Although it's seasonal, the HCL Software segment is known for its very high margins. HCL has successfully increased the revenue share from ER&D + Software business to 25-30% and profit share from them to 35-40%. 

Recent Acquisition: HCL Technologies recently acquired the German automotive engineering services company ASAP Group. This strategic acquisition bolsters HCLTech's global leadership in engineering services, particularly within the fast-growing European automotive engineering services sector. ASAP Group specializes in services aligned with key industry trends, such as e-mobility, autonomous driving, and connectivity.

Recent quarterly performance: 

In Q3 FY '24, HCL Technologies reported strong performance with a 6% sequential and 4.3% YoY revenue growth in constant currency, the highest since Q3 2021. Services revenue grew 3.1% QoQ, and software revenue increased by 5% YoY, driven by subscription and support revenue growth. Operating margins improved to 19.8%, even after accounting for wage hikes. The company received numerous awards, demonstrating leadership in IT services. 

• Across segments: In the software segment, ARR (Annual Recurring Revenue) reached $1.06 bn, growing 2.9% YoY. ER&D showed healthy organic growth of 2.5% QoQ. IT and business services grew 4.3% YoY and 1.9% QoQ in constant currency.
• Across verticals: Telecom and media had outstanding growth of 25.9% QoQ, while manufacturing grew 7.6% QoQ. Financial services declined 1.3% QoQ but had a strong 12.9% YoY growth. Retail grew 2.9% QoQ and 11.7% YoY.
• Across geographies: Europe grew 5% QoQ, Americas grew 3.1% QoQ and 6.7% YoY, and the rest of the world declined 5.3% QoQ.
• Deal wins: HCL added significant clients on an LTM (last 12 months) basis and achieved YTD bookings of $7.5 bn, representing a 10% growth YoY. The company secured 18 large deals in the quarter, expanding its digital transformation partnership with a Fortune 50 consumer packaged goods company.

What's happening to global IT spending?

In the current economic climate, businesses have scaled back investments in digital transformation due to reduced demand. Instead, they are focusing on cost-reduction initiatives. This shift negatively affects services like application development, infrastructure implementation, and consulting, as these require a change in business perspective and are now considered less of a priority amidst the current challenging economic conditions. 

Over the past year, many enterprises have realized that they previously allocated excessive budgets to transformation projects. Now, they are actively streamlining their expenses. Consequently, IT companies are winning a majority of deals related to cost reduction and optimization, shifting away from traditional digital transformation initiatives. 

Has anything changed since last quarter?

Management commentary regarding business sentiment toward discretionary spending remains the same as in the previous quarter. However green shoots of growth were visible in the engineering segment, for FY24 HCL expects to close at 5% to 5.5% YoY growth. Management iterated that the environment is not conducive to increasing margins at this point and thus is focused on gaining wallet share with vendor consolidation deals.

Revenue growth was tepid but margin improvement was a positive. FY24 growth guidance reduced to 5-6% CC from earlier 6-8%

Weak operational performance due to reduction in Digital spends. ER&D segment declined by 5% CC sequentially. However, management commentary is positive with expectation of strong deal bookings in Q2.

HCL Tech (HCLT) reported Q4FY23 revenues of US$3,235mn, down 0.3% QoQ in USD and down 1.2% QoQ in CC terms, with revenues in CC terms up 10.5% YoY. IT and business services (74% of revenues) grew 1.6% QoQ CC, ER&D (16% of revenues) declined 3.8% QoQ CC due to delays in decision-making in discretionary spending, and HCLT's software business (~10% of revenues) fell 14.6% QoQ CC due to seasonality. For FY23, the company's services segment grew 15.8% CC, slightly below the annual guidance of 16-16.5%, and Q4FY23 EBIT margin was 18.2% at Rs48bn.

Muted results due to decrease in margins

Market Cap: Rs. 3,02,400 Cr

CMP 1,110 | P/E 20x FY23

Click here for 10 year X-ray

Key Highlights:

·Company won 17 large deals – 7 services and 10 software, led by themes including operating model transformation, cloud adoption and   vendor consolidation across industry verticals including Financial Services, Retail & CPG and Manufacturing.

·HCLSoftware announced a multi-year partnership with the Formula One team Scuderia Ferrari with a focus on supplying high performance   precision technology.

·Services business grew 15.4% y-o-y and 2.2% sequentially in constant currency.

·Geography growth was once again led by Europe at 7.2% sequentially in constant currency, followed by Americas at 0.5% QoQ in constant   currency.

·Employee count at quarter end was 2,22,270. Net Additions of 2945, LTM Attrition came in at 21.7%

Management Outlook:

·Management sees continuing demand visibility in themes like IT operating model transformation and cloud adoption.

·Management has guided 13.5-14% YoY growth for company revenue in constant currency and 16-16.5% YoY growth in service   revenue   in constant currency for FY23.

·Management has guided that Q4 will be a seasonally weak quarter as a P&P performance peaks in Q3 with renewals and new deal   signings.