HCL Tech Q3 review: Shares fall most in 22 months

Shares of HCL Technologies Ltd. fell the most in nearly two years as analysts expect supply-side pressures to weigh on its margin.

The software services exporter’s EBIT margin remained flat at 19.1% sequentially in the three months ended December. It expects the supply-side challenges to keep FY22 margin at the lower end of the guided 19-21%, with a 10-20-basis-point downside risk as well.

Key Q3 highlights (QoQ)

• Revenue increased 8.1% to Rs 22,331 crore compared with the Rs 21,631-crore forecast.
• Net profit rose 5.6% to Rs 3,442 crore against the Rs 3,374-crore estimate.
• EBIT increased 7.9% to Rs 4,257 crore.
• Declared an interim dividend of Rs 10 apiece.

Peers such as Tata Consultancy Services Ltd., Infosys Ltd. and Wipro Ltd. saw their margin contract and attrition inch up in the reported period. Infosys raised its revenue growth guidance for FY22, while TCS retained its double-digit forecast. Wipro guided for a 2-4% sequential growth.

Shares of HCL Tech declined as much as 7.01%—the most in 22 months—to Rs 1,243.4 apiece as of 10 a.m. Of the 51 analysts tracking the IT company, 42 recommend a ‘buy’, seven suggest a ‘hold’ and two have a ‘sell’ call, according to Bloomberg data. The average of 12-month price targets implies an upside of 16.4%.

Here’s what brokerages have to say about HCL Tech’s Q3 FY22 results:

Nomura

• Maintains ‘buy’, raises target price to Rs 1,580 from Rs 1,560, implying a potential upside of 18.2%.
• While HCL Tech’s revenue surprised positively, margins were weaker than expected.
• Growth in products and platforms was driven by a seasonally strong quarter for licence sales and renewals, and catch-up in revenue shortfall in Q2.
• Growth was broad-based across all geographies and technology, retail and telecom, and media had the strongest growth amongst verticals.
• Headwinds to margin includes salary hikes, seasonality (which is expected to reverse in Q4), certain ramp-up costs in customer projects and from higher retention, bonus payouts and hiring costs.
• In the medium term, selective price hikes and higher fresher hiring could help it improve margins.
• Key risks—slowdown in revenue and margin weakness due to attrition.

Jefferies

• Maintains ‘buy’, hikes target price to Rs 1,580 from Rs 1,530, implying a potential upside of 18.1%.
• While overall margins were flat QoQ, services margins fell 190 bps due to wage pressures.
• Management reiterated its FY22 double-digit growth guidance but now expects margins to be about 19%, with some downside risk.
• Given supply-side pressures and investments, Jefferies lowers its FY23-24 margin estimates by 70-100 basis points and expect margins to remain in the 19-19.2% range over FY22-24.
• While HCL Tech’s margins could remain under pressure from supply-side challenges, its services business growth outlook remains strong.

ICICI Securities

• Maintains ‘reduce’ but raises target price to Rs 1,150 from Rs 890, still implying a potential downside of 14%.
• Services margin declined 190 basis points QoQ, largely due to wage hikes and supply-side challenges, which was fully offset by positive operating leverage in products and platforms segment, resulting in overall margins being flat sequentially.
• Management called out a downside risk to their EBIT margin guidance of 19-21% for FY22 due to need for increased investments. This corroborates ICICI Securities’ argument that the industry is unlikely to see any meaningful margin expansion in the new normal (vs pre-Covid).
• Notably, margins are below pre-covid level with higher intensity of cost headwinds in the foreseeable future.

CLSA

• Maintains ‘outperform’, cuts target price from Rs 1,470 to Rs 1,450, still implying a potential upside of 8%.
• Deal wins remained healthy and support management’s hope for accelerated growth in FY23. However, an aggressive deal perusal is exacerbating the impact of supply-side pressures on near term margin trajectory.
• Weak margin outlook mars the picture. Supply-side pressure appears to be affecting HCL more than peers. CLSA estimates quarterly annualised attrition is still trending up for HCL while it has started to moderate for peers.
• Aggressive intake of campus hires continues and the management commentary indicates an early respite is unlikely.
• Weak near-term prognosis for its margin could weigh on the stock’s near term performance.

Anand Rathi

• Maintains ‘buy’ with a revised target price of Rs 1,550, implying a potential upside of 16%.
• With continuity of robust growth across Mode-2 and Mode-3 business, Anand Rathi expects the growth momentum to continue supported by strong products, deal pipeline and ramp up of large deals.
• Key risks to its call include US H1-B Visa regulations, foreign currency fluctuations and employee attrition.

Nirmal Bang

• Maintains ‘buy’, raises target price to Rs 1,651, implying a potential upside of 23%.
• Sour part of Q3 results was EBIT margin, which was lower than its estimate of 19.9%, primarily due to greater-than-expected margin compression in services.
• Salary hikes, seasonal leave-related costs, retention/recruitment of talent and transition costs were the major drags.
• With the products and platforms business likely to pick up growth in FY23, we see acceleration in overall revenue growth in FY23 vs FY22 with 50-100 basis points of EBIT margin expansion.
• Cloud is acting as one of the key growth catalysts across segments and we continue to believe that HCL Tech has the highest leverage to this opportunity, being among the first in the industry to build dedicated cloud units.
• Investments made by HCL Tech in FY22 will start showing results in FY23.
• With better performance of products and platforms in FY23 and beyond, the street will attribute a greater value to it compared to pre-pandemic days when it was accorded a significant negative value, leading to HCL Tech trading at a significant discount to its peers.
• The FY22 weakness, both in revenue and margin is transitory.

Motilal Oswal

• Maintains ‘buy’ with a target price of Rs 1,690 apiece, implying a potential upside of 26%.
• Higher exposure to cloud, comprising a larger share of non-discretionary spend, offers a better resilience to its portfolio in the current context, with higher demand for cloud, network, security, and digital workplace services.
• Strong sequential growth within services, robust headcount addition, healthy deal wins, and a solid pipeline indicates an improved outlook.
• Given its deep capabilities in the IMS space and strategic partnerships, investments in cloud, and Digital capabilities, Motilal Oswal expects HCL Tech to emerge stronger on the back of an expected increase in enterprise demand for these services.
• HCL Tech continues to struggle to absorb the impact of an adverse supply scenario. While it will be raising prices across accounts, Motilal Oswal expects margin to stay at the lower end of its current guidance for FY23 before recovering in FY24.

Prabhudas Lilladher

• Maintains ‘buy’, cuts target price from Rs 1,400 to Rs 1,398, implying a potential upside of 4.5%.
• Miss in EBIT margin due to wage hikes, supply side cost pressures, new project transition costs and seasonal leaves.
• Management mentioned that only seasonal leaves impact will fully recover in Q4, whereas other headwinds would take time to recover plus they would supply side investments if required resulting in FY22 margins to be near lower end of guidance band (18.8-19%).
• Doubling of freshers in FY23 will also impact margins in near term as it takes average 6 months for them to be billable.
• High products & platforms margins this quarter are not sustainable and are expected to return to average 12-months margins. Margin levers like increased pricing for digital work, automation and pyramid optimization will gradually flow in.
• Inability to absorb cost pressures despite strong revenue growth is a negative surprise and it expects margins to be 19% in FY22/23.

IDBI Capital

• Upgrades from ‘hold’ to ‘buy’ with a target price of Rs 1,545, implying a potential upside of 16%.
• Margin miss is a temporary aberration and it expects margins to improve gradually led by higher contribution of products business, automation, pyramid rationalization and revenue growth.
• HCL Tech is also expected to witness improvement in products led by lower matured products and higher contribution from high growth products. HCL Tech is seeing acceleration in multi-year deal, cloud, cloud consulting, cloud migration, app modernization.
• Deal wins, strong client addition bodes well for revenue growth. In addition, IDBI Capital expects that with improvement in product business, margins will improve in coming quarters.

BloombergQuint