HCL Technologies (HCL Tech) impressed in Q3FY21, with strong all-round performance, led by improving demand for transformational initiatives and strong seasonality in its products and platforms (P&P) business. HCL Technologies reported strong qoq revenue growth of 3.5% on constant currency (CC), exceeding estimate, led by growth in IT and business services (2.7% qoq), ERD (2.5% qoq) and products & platforms segments (8.3% qoq).

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On the vertical front, five of seven HCL Technologies verticals reported positive sequential growth. Mode-2 services clocked a robust revenue growth of 10.9% qoq, led by higher demand for cloud native and digital programs. USD revenues grew 4.4% qoq and 2.9% yoy to $2,616.6 mn. EBIT margin improved 127bps q-o-q to 22.9%, exceeding our estimates, led by S&G leverage (up 80 bps), higher offshoring (up 50 bps) and revenue growth in Mode-2 and ERD business (up 40 bps), which was partially offset by wage revision (-50 bps) and depreciation and amortisation (-30 bps).

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HCL Technologies Net profit of Rs 3981 cr (up 26.7% qoq and 31.1% yoy) was ahead of our estimate aided by strong revenue growth, higher profitability and lower tax provisions. HCL Tech increased revenue growth guidance of 2-3% qoq (including contribution from DWS acquisition) for Q4 FY21 from 1.5% -2.5% earlier. Given its investments in building the differentiated capabilities especially around digital consulting, expertise in application modernisation, offerings across value chains and a strong P&P portfolio, the company is well placed to capture the increasing spends on transformational initiatives and cost take-out programs.

Sharekhan believes HCL Technologies would continue to deliver industry-matching revenue growth in next few years given strong relationships with clients, capabilities in digital foundation and consistent deal wins. The management guided FY2021E margins of 21-21.5% despite margins of 21.7% for 9M FY21, owing to impact of wage revision for senior levels (80-90 bps) and the absence of one time benefit, which was in Q3 FY21.

Key positives for HCL Technologies:

New licence booking TCVs stood at $91 million in P&P business, represents 250% yoy growth
Free cash flow (FCF) stood at $621 million with a FCF to net income conversion of 115%

Key negatives for HCL Technologies:

ERD revenue remained below pre-COVID level, down 5.1% y-o-y on CC Š
Organic revenue growth guidance for Q4 remains soft compared to large peers

Key Risks:

Any integration issues in ongoing M&A activities especially IP-related transactions could impact earnings. Further, high dependence on IMS could create challenges to its revenue growth trajectory.