HCL had reported Q3 results post market close on Friday. In reaction to earnings, the stock was down around 5.3 per cent at the time of writing this, predominantly on margin concerns.

However, concerns on this front may be overdone as according to management they have levers to optimise on margins going forward. Also, as such the margins are within management’s prior FY22 guided range of 19-21 per cent, which it has maintained now.

Revenue growth shines

HCL’s sequential constant currency (CC) revenue growth for the quarter was at 7.6 per cent. This was better than that reported by the other tier-1 IT services companies – Infosys’ 7 per cent, TCS’ 4 per cent and Wipro’s 3 per cent.

While HCL benefitted from base effect and bounce back in its products and platforms business segment (13.5 per cent of revenue) in Q3, even excluding this the CC growth for its remaining IT services business at 5.3 per cent was better than that reported by TCS and Wipro.

Underlying business momentum remains solid with new deal wins of $2.13 billion – up 64 per cent year on year. Broadly the deal momentum has been solid across companies in the large and mid-cap space, driven by digital transformation projects in the developed world. Company saw broad based growth across geographies and verticals.

On the flip side, the better growth was partially a factor in margin miss as it requires some investments early on. Other factors that impacted margins versus expectations were wage hikes and attrition. At the end of Q3, the LTM attrition was at 19.8 per cent versus 10.2 per cent same time last year.

Many companies have been facing this problem in recent quarters as demand for IT skill sets has zoomed post the pandemic, giving employees more leverage. The LTM attrition for Infosys, TCS and Wipro at the end of Q3 were at 25.5, 15.3 and 22.7 per cent, respectively. HCL management is of the view that the attrition trends have likely peaked now and expectations are for it to trend downwards.

Broadly company believes margin levers in the form of better utilisation of large number of freshers recruited over the last year (productivity benefits are seen only few quarters after recruiting), payoffs from some investments for growth made in recent quarters, and possibly better realisations for some of its work based on how successfully HCL is able to negotiate with clients. Given these factors, it appears margins concerns may be overdone.

What lies ahead?

Overall as far as Q3 results are concerned, the positives appear to outweigh the negatives for HCL. Trading down margins in the short term for better growth may be worth pursuing. Going ahead investors need to watch out and track how the margin levers for the future mentioned above play out.

Another key factor that investors need to track are any early signs of slowdown in second half of CY22. The impact of monetary tightening by the Federal Reserve to tackle persistently high inflation and any slowdown in global growth due to that may play out later in the year.

While as of now across the board managements of IT services companies have sounded optimistic on growth prospects for the year, it would be prudent to be watchful on this as aspect as any slowdown would directly impact client IT budgets.

HCL currently trades at 22.8 times one year forward PE. Infosys trades at 31.7 times, TCS at 34.3 times and Wipro at 26.4 times.

From long-term investing perspective, within the tier-1 group, HCL appears a relatively safer stock to stay invested, given its revenue momentum, relatively cheaper valuation (which is not fully warranted) and its differentiated products and platforms strategy which may pay off in the long-term.

In the previous quarter HCL had announced its intentions to have a payout ratio that entails investors payouts of not less than 75 per cent of net income cumulatively over five years (FY22-26). This would be one important factor that will enable bridging the valuation gap versus peers over the medium-term.

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