HCL Technologies Ltd’s December quarter earnings performance was mixed. Its fastest revenue growth in several years has come with a margin performance without motivation. In constant currency terms, revenue grew 7.6% sequentially, driven by a sharp rebound across its products and platforms and the spillover of deals from the September quarter. In a conference call with analysts, HCL’s management said the fiscal third quarter revenue growth was the highest in the past 47 quarters.
What’s more, last quarter, HCL signed eight large services and multiple product deals spanning financial, technology and healthcare services. At the end of December, the total value of its new deals contract stood at $2.1 billion, up 64% from a year earlier. Management said the company’s deal pipeline is strong and comprehensive across all markets and verticals. Therefore, it is not surprising that HCL has retained its double-digit revenue growth guidance for FY22.
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Note that Infosys Ltd., Tata Consultancy Services Ltd. (TCS) and Wipro Ltd.’s sequential revenue growth in the third quarter in constant currency was 7%, 4% and 3%, respectively. While HCL’s outperformance on this parameter is encouraging, the margin show was tremendous. Ebit (earnings before interest and tax) margins were flat 19% compared to the previous three months, well below the consensus estimate of 19.4%.
Management indicated that margins in its key revenue generator — the IT services business segment — fell nearly 2 percentage points quarter-over-quarter from 18.9% to 17%. Analysts said factors such as cost and changes in pay hike, retention and recruitment had an impact on margins. HCL’s management said it expects margins to remain under pressure in the next few quarters. For FY22, Ebit margin could be at the low end of margin guidance of 19-21%. “The margin outlook on IT Services was lower than anticipated as HCL struggles to absorb the impact of the unfavorable supply scenario. Analysts at Motilal Oswal Financial Services Ltd said in a report, “While this will push up prices across all accounts, we expect margins to remain at the low end of our current guidance for FY23 before recovering in FY24.”
Clearly, HCL shares are trading at a discount to their peers. Bloomberg data shows the stock trades at 23.5 times FY23 estimated earnings compared to Infosys (30.5x), TCS (32.9x) and Wipro (25.4x). Thus, looking at HCL’s margin outlook, the valuation of its shares can be expected to maintain gap vis–vis peers.
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