HCL Technologies share price: Nomura says Buy, pegs price target at Rs 1110

Nomura says Q4 results missed expectations as revenues stood at 3% qoq in Constant Currency terms (vs 3.4%) due to weaker than-expected seasonality in the products business. Also the EBIT margins came at 20.4% (below expectations of 21.4%), due to increased hiring and other reasons. However, as far as Order Book is concerned, net new deal wins of USD 3.1bn (implying a book-to-bill of 1.2x) in 4Q was impressive, with a healthy mix of mid and large sized deals. Nomura says Buy with a price target of Rs 1110.

Further, FY22 guidance was broadly in line with:

1) revenue guidance of at-least double-digit growth (vs expectation of 9-11%); Nomura thinks HCL Tech is likely to beat it led by strong deal wins in 4Q and an easy ask rate of 2% CQGR in FY22F;
2) EBIT margin guidance of 19-21% (vs expectation of 20-21%), but excluding the impact of incremental investments, the guidance was broadly in line. HCL Tech management talked about incremental investments (100bp impact) in building capabilities in Mode 2 services, expanding geographic presence and investing in talent. Nomura expects 11.2% USD revenue CAGR over FY21-23F and stable EBIT margins at 20% for F22/23F.

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Nomura reiterates Buy rating, due to following reasons:

1)      improved capabilities in digital foundation areas, visible in strong TCV
2)      better portfolio skew towards IMS/ER&D, highly under penetrated areas coupled with cost take-out opportunities
3)      focus on investments in Mode 2& geo expansion and synergies from the products business,
4)       attractive valuation at 19x FY22F EPS (25-40% discount to Infosys / TCS)

Positives on HCL Tech:

1)      HCL Technologies announced an increase in the quarterly dividend to Rs 6/share (50% payout) and a special dividend of Rs 10/share
2)      IT & Business services, BFSI/ Healthcare and Mode 2 led growth
3)       4Q net new TCV of USD3.1bn was up 49% yoy and FY21 net new TCV of USD7.3bn, up 18% y-y.

Negatives of HCL Tech:

1)      sharp 950bp q-q drop in EBIT margins in the Mode 3 business
2)      increase in ETR to 24-25% going forward on inability to claim tax benefit on goodwill depreciation effective 1 April 2020.

Nomura fine-tuned their revenue estimates, however cut their EBIT margin estimates by 40- 100bps for FY22/23F led by miss in 4Q and increased investments. As a result EPS is lower by 5-8% for FY22F/23F. Nomura now looks for USD revenue/EPS CAGR of 11% and 9%, respectively, over FY21-23F. Nomura continues to value HCL Tech at 19x (25%+ discount to target multiple for Infosys / TCS) 1-year forward EPS.

Downside risks on HCL Technologies:

Inability to add capabilities in digital, acquisitions in legacy areas and weaker-than-expected margins