Neutral HCL Technologies, target Rs 1,150: MotilalOswal Financial Services

MotilalOswalFiancial Serviceshas a ‘neutral’ call on HCL Technologies (HCLT) with a target price of Rs 1,150. 

Shares of HCL Technologies traded at Rs 1,067.55 around 1 pm on 8 August, 2019. The brokerage has set a one-year horizon for the stock to hit the target price. 

“We maintain neutral as we watch out for the revenue performance from IPs post the integration next quarter,” said the brokerage.

The view of the brokerage: 

Mixed performance – strong revenue but weak margins

Constant currency (CC) revenue grew 17 per cent year-on-year (YoY) (brokerage’s estimate: 14 per cent), Ebit was up 2.7 per cent YoY (brokerage’s estimate: 8 per cent), while PAT declined 7.7 per cent YoY (brokerage’s estimate: up 1 per cent YoY) in Q1FY20. 

Ebit margin shrank 180bp quarter-on-quarter (QoQ)to 17.1 per cent (a 130bp miss) against the full year guidance range of 18.5-19.5 per cent. 

“Multiple factors contributed to the contraction, but the miss was led by weak margins in Engineering Services, where the company had one write-off, investments and also onsite-centric deal ramp-ups,” said the brokerage. 

PAT declined 13.5 per cent QoQ and 7.7 per cent YoY to Rs 2,220 crore (8 per cent miss against our estimate of Rs 2,420 crore) due to a higher tax rate (24 per cent against estimate of 19.3 per cent) and lower operating income. 

What drove better organic revenue momentum?

As per the brokerage, HCLT had anticipated headwinds from three clients- two in Financial Services (FS) and one in Manufacturing. 

Against these, there was a large deal ramp-up expected to happen later. However, HCLT was able to transition sooner and book revenues from the deal. 

On the other hand, in one of the troubled accounts, it saw a turnaround and the ramp-down in the other two was lower than expected. 

Upped organic growth outlook still bakes in cautious macro 

HCLT kept its overall revenue growth guidance of 14-16 per cent YoY CC unchanged for FY20. 

However, it now expects organic growth to be 8-10 per cent (1pp higher), offset by lower inorganic contribution due to one month’s delay in the integration of IBM IP purchases. 

Organic growth still appears conservative, considering 14 per cent YoY CC clocked in Q1FY20. 

The reason for not increasing it any further is the macro and the trade situation, which can spring in surprises. 

Earnings cut largely on higher tax rate 

“Despite a strong top-line performance, our earnings per share (EPS) estimates are down by 6.5-8 per cent for FY20/21, of which 6pp is on account of the higher effective tax rate at 24 per cent (against 19-20 per cent earlier), arising due to goodwill from IBM’s IP purchases,” said the brokerage.

Barring that, 70-80bp moderation in the Ebit margin estimate was partly offset by a 1.6 per cent upgrade in our revenue estimate. 

“We continue to separately value IPs (nearly $3 billion in total) at 8 times – a multiple that assumes no growth in the portfolio of IPs,” the brokerage added. This contributes Rs 100 per share to HCLT’s value.

“For the remaining IT Services business, our target price of Rs 1,050 discounts forward earnings by 14 times as the organic growth trajectory inches up. Consequently, our target price of Rs 1,150 implies an upside of 12 per cent,” the brokerage said. 

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