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HCL Technologies Ltd on Friday reported decent growth in the fiscal second quarter, with revenue increasing by 4.5% sequentially in constant currency—a step ahead of Street estimates.

The company’s shares, however, dipped about 4% post the announcement as the higher earnings were already built into the valuations. The stock has already risen about 33% from its pre-covid highs, and 120% since the March lows.

HCL Tech’s 6.4% sequential increase in dollar revenue compares well with its peers. The recovery in IT spends and deliveries is visible with all the verticals doing well. The main vertical of IT and business services grew 4.9% sequentially. Revenue growth is also broad-based across geographies.

Deal wins remained high with the company striking some 15 of them in Q2.

HCL Tech also retained its guidance at 1.5-2.5% for the coming quarters despite the sharp growth in Q2FY21.

HCL Tech's  Q2 Revenue
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HCL Tech's Q2 Revenue

“With supply-side constraints coming off this quarter, some of the operational impediments are now behind. This has also added to the revenue recovery seen in Q2," said Nitin Padmanabhan, analyst, Investec Capital Services.

HCL Tech’s margin improvement is encouraging given lower direct costs and higher offshoring gains. The firm’s Ebit (earnings before interest and taxes) margins stood at 21.6% in Q2, up 110 basis points sequentially.

Some of its verticals have been able to command higher margins. Besides, cost controls due to the pandemic—such as in travel expenses—are also aiding margin expansion.

“HCL Tech’s 110bps sequential margin expansion was driven by 103bps sequential margin expansion in IT services and 350bps sequential margin expansion in engineering and R&D services possibly due to the revenue recovery in this segment. Outsourcing costs were stable sequentially and other expenses fell. These two combined accounted for about 90bps sequential margin expansion," said Jefferies India in a note post the results.

HCL Tech has also raised its margin guidance for the coming quarters. Its improved guidance of 20-21% as against 19.5-20.5% shows that some of the cost control modes are sustainable. Besides, it also lowered its working capital requirements and saw higher cash flow generation.

“Our operating cash flow and free cash flow stand at a handsome $2,692 million and $2,444 million respectively on the last 12-month basis with operating cash flow on net income and free cash flow on net income at an impressive 161% and 146% respectively," said Prateek Aggarwal, CFO, HCL Technologies.

The impact on profit growth was also impressive—the company’s consolidated net profit rose 18.5% year-on-year to 3,142 crore in Q2.

Nevertheless, some analysts had earlier pointed out that HCL Tech had disappointed with a lack of clarity over its payout policy on dividends. So, the increase in the dividend to 4 per quarter (from 2 earlier) is a consolation.

But it does not appear like the Street will increase earnings forecasts for the coming year. On that count, HCL Tech’s valuations at about 17 times one-year forward price-earnings as per Bloomberg data seems reasonable. Note that larger peers like Infosys Ltd and TCS Ltd’s stock valuations are about 23-27 times.

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Updated: 17 Oct 2020, 07:40 AM IST
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