by Suhani Adilabadkar
HCL Tech delivered a strong set of numbers in December Q3FY20 powered by its twin organic and inorganic growth engines. The third largest software services company in India reported double digit growth momentum, presented strong guidance in Q3FY20 and seems to be confident of overcoming the coronavirus pandemic.
HCL, a leading global technology company operating in 44 countries, had consolidated revenues of $9.7 billion as on t December 31, 2019. The company follows a three lane growth strategy, by reporting revenue segmentation through its Mode 1-2-3 approach initiated in 2016.
Mode 1 encompasses core services, i.e applications, infrastructure, BPO, engineering and R&D services. Mode 2 is all about digital & analytics, IoT, cloud native services and cybersecurity and Mode 3 strategy creates innovative IP–partnerships to build products and platforms business. HCL Tech toppled Wipro from the third spot in terms of dollar revenues in 2018, and has been growing above the industry average for the last two years.
Quick Takes
HCL Tech reported the highest revenue growth in the top IT quartile, 15.5% YoY at Rs. 18,135 crore in Q3FY20.
Operating profit for the quarter stood at Rs. 4,629 crore rising 27% YoY and PAT jumped 13% YoY.
Mode-3 grew 53% YoY while Mode-1 and Mode-2 moved positively 7.5% and 22% YoY respectively.
After lower margins in Q1FY20, a conscious decision was apparently taken to "gradually remove certain accounts not yielding enough strategic value" to maintain margins.
According to management, COVID-19 will not have any significant impact as the company's exposure to vulnerable verticals, oil and gas, travel and hospitality, high end retail is in single digits.
December quarter saw software business drive revenue growth
HCL Tech reported highest revenue growth in the top IT quartile, 15.5% YoY at Rs. 18,135 crore in Q3FY20 against Rs. 15,699 crore in the same period, previous year aided by strong performance of HCL Software business unit (acquired IBM products). Operating profit for the quarter stood at Rs. 4,629 crore compared to Rs. 3,632 crore corresponding quarter, previous year, rising 27% YoY supported by mode 2 and mode 3 sturdy performance.
Operating margin at 25.5% expanded 239 bps YoY in Q3FY20. Net Profit or PAT for Q3FY20 came out at Rs. 2,944 crore compared to Rs. 2,605 crore growing 13% YoY. Though there was a slight dip in order booking, HCL Tech reported strong and stable numbers with Mode 3 or products platforms being the major growth driver. DSO is at 83 days in Q3FY20, down 7 days compared to Q2FY20 which was at 90 days. Free cash flow stood at $657 mn with OCF to net income ratio standing at 166% for the December quarter FY20.
Analysis: giving up low-margin accounts
HCL Tech is the dark horse of Indian IT industry, as per the analyst community. The company has been growing at a CAGR of 24% and 21% for revenue and net profit respectively for the past three years higher than market leader TCS and runner up Infosys. In the current quarter, HCL Tech has crossed an important milestone of annualized revenue run rate of $10 bn in the December quarter FY20 and delivered two consecutive quarters of more than 20% EBIT.
With respect to vertical performance, with the exception of technology which dived 6% and healthcare with a high single digit performance of 9%, the remaining verticals grew in strong double digits with financial services, manufacturing, retail, telecom and energy expanding 17%, 38%, 17%, 14% and 31% YOY on constant currency basis (cc) in Q3FY20.
RoW topped the list in geographic performance at 27% YoY cc followed by Europe at 21% and Americas at 13% YoY cc in Q3FY20.
Mode wise performance is now completely tilted towards Mode-3 (products & platform segment), representing 16% of revenue mix and growing 53% YoY while Mode-1 (66% of revenues) and Mode-2 (18% of revenues) moved positively 7.5% and 22% YoY respectively. On a sequential basis, Mode-3 jumped 11% YoY while Mode-1 and Mode-2 were constant. Combined revenue of Mode 2 and 3 stands at 34% of total revenues in Q3FY20.
With respect to the December quarterly performance, the US reported relatively lower growth in Q3FY20. In this regard, management said that there were two major factors, first furlough impact and secondly after lower margins in Q1FY20, a conscious decision was apparently taken to "gradually remove certain accounts not yielding enough strategic value" to maintain margins. Thus, margins improved across the board and though revenue growth weakened, the management says it is confident of good momentum in their core services in the coming quarters.
HCL Software: renamed IBM product line 'outstanding', says management
HCL Software, carved out by HCL Tech, encompasses select IBM products acquired by the company in December 2018 at a cost of $1.8 bn. Analysts had given a lukewarm response to the acquisition with the stock declining 8% after the IBM deal was announced.
Speaking about the new business unit, Mr. C. Vijaykumar, President & CEO, HCL Tech said, “HCL Software business delivered an outstanding performance which has helped the products and platforms segment to grow by 16.8% QoQ in constant currency. While we were always very confident of our strategy in investments in the software products business, this quarter is a fitting validation of what this business can do not only in terms of growth in revenues, high profitability and also excellent cash conversion”.
HCL Software had reported 1,500 transactions in the second quarter of its operation (Q2 FY20) which have increased 3 times in transactional value, 5,000 transactions in the December quarter FY20. In addition to that, 4,600 customers have boarded over the past six months in over 90 countries. Earlier on a revenue sharing model for these IP products with IBM, HCL Tech would be favourably placed in the long run with sole ownership of these products and positioning itself as a strong enterprise software player in Indian IT industry adding significantly to its shareholder value in the long run.
Though there was a dip in bookings QoQ as clients are taking longer timeframe for decision making, the company is confident of its pipeline, Mr Vijaykumar said, “The good news is our qualified pipeline is at an all-time high in the recent past and we were expecting a higher conversion of pipeline to booking this quarter”.
COVID-19 is expected to impact all of this, but management is not for now, expecting a significant impact as its exposure to vulnerable verticals, oil and gas, travel and hospitality, high end retail is in single digits. In addition to this, HCL Tech says bookings are largely on track and significant parts of closures have already happened. It would be interesting to watch, whether revenue guidance, 16.5% -17% narrowed from 15-17% (given in Q2FY20) and EBIT raised from 18.5% to 19.5% at the beginning of the year to 19% to 19.5% for the full year would be achievable.