Stock Call. Why HCL Technologies is a good long-term bet

Investors with a perspective of at least three years can consider investing in the HCL Technologies stock. The IT services sector will not be spared from the fallout of the Covid-19 pandemic in the near term. This pain will likely to last the whole of FY2020-21. Beyond that, there will be a faster adoption of digital services across industries, which HCL Tech is well-positioned to benefit from.

Besides, the company has a diversified portfolio of services it offers, and also a nascent products business that will hold it in good stead and aid margins. Its reasonable valuation compared with peers makes it an attractive bet for investors.

HCL Tech delivered a double-digit revenue growth for FY2019-20 when none of its top-tier peers such as Infosys or TCS could manage to do so. It also managed to meet its margin guidance for 2019-20.

The company appears relatively better-placed among peers to weather the pandemic, thanks to its early preparedness for the lockdown as well as a healthy order book for FY21.

The stock trades at a 12-month trailing consolidated price-to-earnings (PE) multiple of 12.7 times compared with its three-year average PE multiple of 14.6 times, presenting a good opportunity for long-term investors.

Cushion for Covid-19 impact

The company is reasonably well-placed to tide over the Covid-19 impact in the near-to-medium term. HCL Tech was quick off the block to steady the ship when the pandemic ravaged China.

The company put plans in motion very early (in February) to enable employees to start working from home in the event of a lockdown.

This helped the company avoid any impact on revenue due to the lockdown imposed by the Centre in March.

As a result of the company being nimble and its early response to the pandemic, the revenue impact was negligible during the quarter ended March 31, 2020.

In the quarter, HCL Tech’s revenues rose 2.5 per cent quarter-on-quarter to ₹18,587 crore. Net profit rose 7.7 per cent for the same period to ₹3,154 crore.

The company also posted a stellar margin of 20.9 per cent during the quarter. To tide over the impact of the pandemic, the company has paused new hiring and implemented some stringent cost-control measures. Looking forward to financial year 2020-21, there is going to be some pain in the first half of the fiscal. This will be due to customers seeking longer credit periods and discounts for the first two quarters of FY21.

However, the management does not expect these requests from customers to occur beyond September 2020. Things are expected to stabilise from the second half, but due to uncertainty, the company has avoided giving any revenue or margin guidance for FY21.

Secondly, the volume-based billings, based on the number of employees or servers serviced by HCL Tech, will be impacted over the next financial year.

This is because, as clients curtail operations, it will directly impact the number of employees or servers serviced by the company.

Manufacturing, entertainment and non-grocery retail verticals could be the most impacted by the pandemic. Manufacturing, which constitutes around 20 per cent of the company’s revenues, will face the heat because automotive and aerospace industries will see a lull.

But the good thing is that revenue exposure to entertainment and non-grocery vertical is not that large.

Besides, verticals which will see low impact or will remain resilient, such as financial services, telecom, life sciences & healthcare and technology services,s constitute nearly 30 per cent of the company’s total revenues.

Products business holds promise

Another factor working in favour of HCL is the fact that the company has a decent pipeline and order inflow that will see it through FY21.

The firm expects some of the deals that it signed in the quarter ended March 31, 2020 to start coming on stream by the June-September quarter in FY21.

Also, the products and platforms business (includes IBM products suite acquired in December 2018) is doing well and is aiding margin growth.

The firm had concluded the purchase of IBM products in July 2019. It is selling these products to many of its existing customers. This business segment is also the least affected by the pandemic, despite seeing some sluggishness recently.

Opportunity in digital

As the pandemic unfolds globally, many digital services that businesses were going to adopt over the next 3-4 years will be advanced.

This will mean more business opportunities for companies like HCL Tech over the next two financial years. Vendor consolidation is inevitable — smaller or boutique IT services companies will lose out to larger firms.

More businesses will adopt solutions to enable remote working and operations. Digital channels of sales will gain primacy and so will demand for managed services on cloud platforms, telemedicine, cyber security, and cloud migration. With vendor consolidation a given in the IT services space, these services present a good opportunity for top-tier Indian IT services firms like HCL Tech.

Annual financials

In FY20, the company posted a constant currency revenue growth of 16.7 per cent year-on year to $9.94 billion, which was at the top-end of its guided range, with 10.7 per cent organic revenue growth.

Some cost-control measures allowed it to post earnings before interest and taxes (EBIT) margins of 19.6 per cent, and meet its margin guidance for the year.

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