HCL Tech is among India’s top five IT services companies, providing IT solutions, remote infrastructure management, BPO services, and engineering-related services. And its fortunes are closely tied to the global economy: the majority of its revenues come from customers in the US and Europe.

While the street was expecting IT services to have a muted Q2, actual results have so far beat expectations with most top tier IT companies posting better than expected results. HCL declared results last week, beating Trendlyne Forecaster estimates by 3% on net profits.

In the earnings conference call with analysts, the CEO and MD, C.Vijayakumar noted that the company “delivered growth..which is broad-based across all segments, all sectors and geographies, and a healthy margin performance.“

Quick Takes 

• HCL Tech’s revenue was up by 15.8% in CC (constant currency) terms at Rs 24,686 crore in Q2FY23
• Revenues of $3,082 Mn in Q2FY23, up 10.4% YoY in Q2FY23
• HCL Tech’s EBIT margins stood at 18%, sequentially up by 0.93% in Q2FY23
• New deals signed in Q2FY23 include $2.4bn net-new TCV (Total Contract Value), a sequential growth of 16%, with a mega deal of $625mn TCV, a  multi year contract
• Highest ever fresher hiring of 10,339 in Q2FY23 and target of hiring 30,000 freshers for FY23
• The management increased guidance for services revenue growth 16%–17% YoY in CC terms for FY23 from 12%-15% earlier.

Every vertical delivers growth in Q2FY23

Analysts had speculated that a slowdown in the US due to rising inflation and the Russia-Ukraine conflict in Europe might lead to lower IT spends by clients. But one fundamental aspect of the IT sector is that it often helps drive the core business of most of its clients. Hence the assumption that IT spending can be reduced may not hold, even during a downturn.

Another aspect is that IT services companies are technology oriented and keep adopting the latest approaches. So while IT spending may be deferred, it is unlikely to substantially reduce in the coming quarters as customers keep upgrading their tech stacks. HCL Tech’s results prove this so far, with all verticals delivering a healthy YoY growth this quarter.

In Q2FY3, revenue growth stood at 15.8% YoY in CC (constant currency) and 3.8% QoQ CC, with total consolidated revenues of Rs 24, 922 crore. In IT Services, growth was led by Europe at 6.9% QoQ, followed by the US at 4.7% in CC terms. Among verticals, growth was led by telecom, which grew at 27.1% in CC terms.

HCL Tech’s revenues have been consistently rising over the last four quarters. However profits have not risen in sync with revenue growth. Escalated operational costs, wage hikes to tackle growing attrition and the cross currency challenges with the US$ and Euro have played spoilsport.

According to the management, clients are still accelerating their digital transformation journey, which is providing them with business benefits while reducing operating cost. They added however, that macro uncertainty is weighing on a number of clients, and that clients are re-assigning spends and projects. A lot of clients are lagging behind in consuming cloud capacity and need to accelerate spending to consume the same.

HCL Tech boasts of new deal wins and strength in verticals, cloud infrastructure 

New deal TCV rose 16% QoQ and 6% YoY to $2.4Bn in Q2FY23. It also bagged a mega deal, with a value of $125m for five years beginning FY24. The management said the mega deal was a result of synergies from the public services vertical.

HCL Tech has higher exposure to cloud, which comprises a larger share of customers' non-discretionary spends. This has led to  resilience for its overall portfolio in the current context, with higher demand for Cloud, Network, Security, and Digital workplace services.

Given its capabilities in IMS (Infrastructure Management Services), digital space and strategic partnerships, as well as investments in cloud, it could emerge stronger with an increase in enterprise demand for these services in the next few quarters.

HCL Tech’s revenue growth momentum is expected to continue, led by several large deal wins in the past few quarters and gradual recovery in infrastructure management services. The company has focused on chasing large deals to capture market share. Being the leader in IMS practices and the third-largest engineering services player globally in revenue, the company is well positioned to win these  large deals. 

The management earlier expected margin at 18% (lower-end of its previous guidance). It now expects margin to be in the 18-19% range for FY23.

The strong growth guidance and margin performance despite wage hikes, especially when the demand for IT services is expected to be incrementally weaker, should improve investor confidence in its business and other larger Tier-1 IT services peers. 

 

There is a ‘but’: HCL Tech is losing a lot of people every quarter

While there are many bright spots as seen from the results, there are many areas of concern. The biggest one is the high attrition rate. The attrition rates for HCL Tech have been consistently rising over the past four quarters and is at the highest level recorded, of 24% in both Q2 and Q1 this financial year. While the management claims to have taken steps to contain this, the numbers tell a different story. Employees are leaving in droves, taking their training and knowledge with them, and forcing the company to spend more on onboarding and training their replacements. 

Another challenge for HCL Tech is the absence of new clients in this quarter, specifically in the category of high value deals worth $100mn and $50mn. Rupee depreciation and adverse cross currency movements also pose potential roadblocks. 

The multiple negative drivers around the IT industry makes a cautious approach to IT stocks advisable. Even though HCL Tech delivered results above street expectations, a host of uncertainties and how they play out will decide whether it can continue to beat expectations next quarter.