HCL serves up a heady cocktail, but valuation leaves no room for error

Sequential constant-currency (CC) revenue growth of 3.8% was below the consensus estimate of 4.2%, dragged down by weaker-than-anticipated performance of the software business owing to delays in deal closures and renewals. On the other hand, the services business growth fared better despite furloughs and seasonality. 

This swift fall in the stock price indicates that Street’s expectations were elevated to begin with. Muted equity market sentiment may also have accentuated the pain for HCL stock.

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Overall discretionary IT demand is picking up, but company-specific issues could hurt HCL’s Q4FY25 performance. Management attributed this to a planned ramp-down of the Verizon deal and some project completions. The impact of this will be visible in the retail, consumer packaged goods (CPG) and telecom verticals of the services business in Q4. HCL also spoke about a slower ramp-up of discretionary deals, which is a dampener considering short-cycle deals are gaining momentum.

The total contract value (TCV) of new deals was around $2.1 billion in Q3 versus $2.2 billion in Q2. HCL did not win any mega deals in Q3. Management said its deal pipeline was very strong and near record highs. HDFC Securities pointed out that HCL’s new deal TCV remains soft and lower than the target of $2.3-2.5 billion. So, shorter deal durations could support near-term growth aided by improving annual contract value. But the pace at which shorter deals are ramped up is crucial.

Growth guidance revised

HCL lifted the bottom end of its FY25 revenue growth guidance from 3.5% to 4.5%. Its FY25 constant-currency year-on-year revenue growth guidance now stands at 4.5-5%. The revised guidance includes HP’s CTG acquisition (around 50 basis points impact). Hence, at the mid-point, organic growth guidance is unchanged.

Management noted that the ask rate for Q4FY25 is -1.3% to +0.6% on a sequential basis in constant currency terms. A soft Q4 exit rate has triggered fears of HCL’s year-on-year revenue growth being hurt. “We are factoring in the unanticipated delays and planned ramp down, baking in revenue growth of 4.8% YoY CC (5.3% earlier) in FY25,” said a Prabhudas Lilladher report. Some brokerages have also cut FY25 earnings-per-share estimates.

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The earnings before interest and tax (Ebit) margin expanded 90 basis points sequentially to 19.5%, aided by operating efficiency measures and forex benefit. Margins may decline in Q4 due to the impact of salary hikes to junior staff and weaker-than-usual growth in the high-margin software business. HCL retained its FY25 Ebit margin guidance at 18-19%.

A relatively low exposure to the troubled banking, financial services and insurance (BFSI) sector stood HCL in good stead relative to its peers. HCL stock is up 17% in the past six months, beating the Nifty IT index’s 11% return. HCL is trading at an FY26 price-to-earnings multiple of 26x, shows Bloomberg data. In comparison, Tata Consultancy Services Ltd and Infosys Ltd trade at 28x and 27x, respectively. Simply put, HCL’s valuation leaves no scope for disappointment, especially since its valuation is almost at par with Infosys, which is seen as a major beneficiary of the revival in discretionary demand.

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“The company has considerable exposure to verticals that face demand headwinds (manufacturing and telecom) and a couple of verticals where discretionary spending is taking time to improve (healthcare and public services). These verticals contribute to 56% of revenue and can slow down the recovery pace,” said a Kotak Institutional Equities report dated 13 January.