Why HCL Technologies’ stock lost steam despite decent Q4 earnings
Decent revenue growth and stable profit margin turned out by HCL Technologies Ltd for the March (Q4) quarter, plus new client additions, did not cheer investors. After an initial rally in the opening hours of Thursday’s trading session, the stock closed a tad lower than the previous day’s closing. Here’s why:
Net revenue for the quarter grew by 3.8% in constant currency terms and 4.1% in dollar terms on a quarter-on-quarter basis. Yes, this met forecasts on the Street but it includes revenue from a slew of recent acquisitions like Geometric Ltd and Butler America Aerospace Llc. Organic growth may have been barely 2%, which was not exceptional compared to the performance of its peers during the same quarter.
That’s not all. Equity investors look forward to the management guidance for the forthcoming year to calibrate earnings estimates. HCL Technologies’ fiscal year 2018 (FY18) guidance of 10.5-12.5% in constant currency terms was a tad weaker than what the Street had pencilled in. Besides, it includes the full impact of mergers and acquisitions that may range between 300-400 basis points, which implies an organic growth of 7-9%, again not better than its peers as was expected on the street. Note that Infosys Ltd and Cognizant Technologies Solutions Corp. have indicated revenue growth of 6.1-8.1% and 8-10%, respectively, for the current year.
Of course, HCL Technologies’ performance has positives too. At 22%, the March quarter’s operating margin met Bloomberg’s 28-analysts’ average estimate. It tripped only marginally when compared to both a year ago and the preceding quarter. The company also displayed robust growth across verticals. Services to the manufacturing sector expanded by about 6%, while banking and financial services grew by 3% quarter-on-quarter.
HCL Technologies has also fared well in the US, although the European business contracted quarter-on-quarter. However, the beat on net profit at Rs2,325 crore was aided by lower taxes.
Another feather in its cap is the strong guidance for EBIT (earnings before interest and tax) margins at 19.5-20.5% for FY18 compared to 20.5% in FY17. Perhaps the fact that its services are spread across sectors would hold it in good stead as most leaders in the IT universe like Infosys and Cognizant are faced with challenges of scalability, which consequently weigh on profitability.
Indeed, the ability to hold on to margins could be why the stock is holding up too. India Infoline Ltd reckons this as a key positive given the margin risks for the industry from rupee appreciation, acquisition integration, and US hiring and pricing pressures. Another brownie point for HCL Technologies is that its attrition rate declined for the seventh quarter in a row.
There is little doubt that the company is on firm ground with decent revenue growth, gains coming from acquisitions and stable profitability. Yet, as the fourth largest IT services provider, its stock at Rs839 trades at 13 times estimated earnings for FY18, a tad lower than Tata Consultancy Services Ltd, Wipro Ltd and Infosys that trade in a band of 15-17. A revenue beat in FY18 would perhaps give HCL Technologies a leg-up to match its peer valuation.