If you are looking for a long-term pick from the large-cap IT space, you can consider HCL Technologies. Good revenue visibility given the recovery in the IMS (infrastructure management services) segment, strong deal wins over the last few quarters and increase in the number of new clients in the $50-million-plus bucket are arguments in favor of the stock. In the last year, the stock has corrected over 15 per cent. The company missed Bloomberg’s consensus estimates on earnings in the March and the June quarter of 2015. Deal wins, though good, didn’t materialize into revenues and margins too dropped. But it looks like the worst is behind for the company.
In the December quarter, the IMS segment helped the company record a 2.1 per cent growth in revenue in constant currency terms versus 1.2 per cent in the September quarter. The management also indicated a good line-up of deals that can help it register stronger growth in the next six months. Operating profit margin was up 80 basis points sequentially, thanks to increase in utilisation.
The stock now trades at an attractive price-to-earnings ratio of 13.5 times on estimated earnings for 2016-17 (it was trading at about 15 times three months back), just a tad expensive compared with Wipro.
In the last two years, the stock has traded in the PE band of 13-18 times.
Improving revenue growth
IMS, which contributes about a third of HCL Technologies’ revenue, was reporting lacklustre growth until recently. In the September 2015 quarter, the segment reported a sequential growth of just 0.9 per cent. Though the management attributed this to seasonal trends in the India business, the market feared that the company lost share to competitors. However, the company belied market apprehensions in the December quarter as the IMS segment recorded 3.4 per cent revenue growth (sequential). The segment’s growth should be better in the next six months. Of the 10 large IMS deal wins in the September quarter, only two were concluded in the December quarter. The others are likely to be closed in the March and June quarters.
Among verticals, retail and public services that together account for 30 per cent of revenue, continue to grow strongly. They recorded revenue growth of 10.3 per cent and 8.4 per cent, respectively, in the December quarter over the September quarter. Financial services (26 per cent of revenues) and manufacturing (33 per cent of revenues) — the two large verticals still show some weakness. While the former recorded a moderate 1.9 per cent growth in the December quarter, revenue of the latter dropped 1.3 per cent. Lacklustre performance of the two verticals follow a stressed global banking sector and slowing revenues from the US.
In the December quarter, the company added one client in the $50-million-plus and two clients in the $40-million-plus buckets.
It did a good job in mining existing clients too. Revenue from existing clients was at 96 per cent, up from 95.1 per cent in the same quarter last year.
Last week, the company announced acquisition of Swedish vehicle major Volvo group’s external IT business for $138 million. This deal will give HCL 40 new customers from Northern Europe and France. The company has also signed an IT deal with Volvo to help it benefit in its infrastructure and application operations.
Margins improve
Profit margins have been moving south for all IT players, given the increased investment in digital solutions, higher M&A activity and competition pressure in legacy services.
In the September quarter, HCL’s operating profit margin was 20.72 per cent, a decline of 0.7 percentage points over the previous quarter and four percentage points over the previous year. However, in the December quarter, operating margins expanded 0.8 percentage points sequentially despite many one-off expenses due to the Chennai floods. Employee utilisation improved to 84.7 per cent from 83.6 per cent in the previous quarter.
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