11 July 2016
HCL Tech stock analysts' favourite - Focus on large deals makes valuations reasonable
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As visible from the relative performance-valuation- table, the market has severely punished HCL Technologies in recent months. Three factors have contributed to its derating. First, the slowdown in the company's infrastructure services business that contributes around 36% to HCL Tech's revenue. Second, the company's margin contraction- margin has contracted in the January-March quarter compared to same period last year. Third, investor sentiment has also taken a hit because of the management's decision to stop giving margin guidance.
Even as HCL Tech's growth from infrastructure services business came down in 2015-16, it was still able to report the fastest growth among peers. This indicates that HCL Tech was able to withstand the increased competition in the space. The concern about Indian IT companies losing their grip over infrastructure services business is also unwanted. Though there is a structural slowdown in infrastructure services business because of the shift towards cloud-based computing, the market share of Indian IT companies in this space is still low and, therefore, is likely to remain as its main area of growth. And, due to HCL Tech's strong hold in the infrastructure services business, analysts are hopeful that its growth will accelerate in 2016-17.
Margin contraction and the management's decision to stop giving margin guidance have increased the investors' worries. However, analysts feel that there is no 'margin uncertainty' for HCL Tech. The expected margin contraction of around 100 basis points, in the coming years, is due to clearly 'quantifiable' factors such as margin-dilutive acquisitions (acquisitions that reduce the average margin of the acquirer) and low-margin mega deals such as Geometric and Volvo. HCL Tech has signed seven large deals worth $2 billion in the January-March quarter. In addition to helping the company improve its credentials, these mega deals are adding to its order book and should help improve its growth rates. Though the margin may contract a bit, HCL Tech's strategy of focusing on mega deals may help it to break out of the slowing growth trend and raise growth rates to match the best in the industry.
After the recent correction, reasonable valuation is another factor-it is the cheapest stock among the top five Indian IT services companies-that is driving more analysts to the buy side in this counter.