Thursday, October 3, 2024

Amid no-show Q4, IT investors scout for silver linings

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The stock of HCL Technologies Ltd is standing out amid a tough demand environment for information technology (IT) companies. So far this year, HCL’s shares have fallen under a per cent—better than most tier-1 competitors and also the Nifty IT index, which has dropped almost 6%. Clients are delaying discretionary expenditure and it helps that HCL has a relatively higher exposure to cloud, which is more non-discretionary in nature.

True, HCL’s revenue growth guidance for FY25 is below analysts’ expectations at 3-5% in constant currency (CC) terms. The lower guidance was attributed to higher offshoring at one of the clients in Q1, which is expected to lead to a 2% sequential decline in Q1FY25. Additionally, divestment of its joint venture with US firm State Street will reflect in earnings from Q2FY25.

Even so, the company is likely to fare relatively better. Motilal Oswal Financial Services expects HCL’s FY25 revenue growth to be near the upper-end of its guidance band, which will put the company ahead of its large-cap IT services peer set barring Tata Consultancy Services Ltd (TCS), which is executing the mega BSNL deal, and LTIMindtree Ltd. “While we expect some near-term pressure on the stock on account of weak FY25 revenue growth guidance, we continue to expect the stock to outperform its peers,” wrote Motilal’s analyst Mukul Garg in a report on 27 April.





In the March quarter (Q4FY24) results announced post-market hours on Friday, HCL saw muted consolidated CC revenue growth of 0.3% sequentially.That said, itskeyIT and Business Services CC growth at 4% was ahead of consensus estimates.Further, new deal-wins at $2,290 million rose year-on-year and sequentially. The deal pipeline continues to grow and remains healthy, the management said. But wage hikes hurt Ebit (earnings before interest and tax) margin, which stood at 17.6% in Q4. While the management has retained Ebit margin guidance of 18-19% for FY25, it believes FY25 to be a year of consolidation on both demand and supply side. In the longer run, HCL continues to aim for a 19-20% margin.

As such, the revenue performance of most tier-1 IT companies in Q4FY24 was nothing to write home about. Further, the subdued FY25 and Q1FY25 revenue guidance by Infosys Ltd and Wipro Ltd, respectively, paints a grim picture; keeping the sector’s near-term revenue visibility low despite robust deal wins.

In this backdrop, dejected IT investors can pick and choose potential positives in management commentary and latch on to a sliver of hope. A case in point is Tech Mahindra Ltd. The stock jumped nearly 8% on Friday after the Street got enthused by its turnaround strategy. The struggling IT firm aims to achieve above peer average growth, 15% Ebit margin and 30%+ ROCE (return on capital employed) by FY27. Among other steps to meet these goals, Tech Mahindra has launched Project Fortius to drive cost efficiencies over the next three years. It expects average savings of $250 million per annum from this.

Investors’ excitement overshadowed Tech Mahindra’s subdued Q4FY24 results wherein sequential CC revenue fell 0.8% with its key vertical of communications, media and entertainment continuing to see dismal performance.Deal wins stood at $500 million and included two large deals worth over $100 million.Despite the sequential improvement, the deal win trajectory stays in slow lane and below the normalized range of $800 million, points out an ICICI Securities report.

In Q4, Ebit margin at 7.4%, rose 200 basis points sequentially. However, the outlook for FY25 is unexciting as the company expects year-on-year revenue growth to turn positive by Q4FY25. This means investors should keep their earnings growth expectations low. “TechM is on the right track in its turnaround journey. However, the journey is long and made arduous due to the tough environment making it prudent to bake in a margin of safety,” said a Kotak Institutional Equities report. The brokerage bakes in weaker near-term outlook, resulting in a 2-4% cut in FY2025-27E dollar revenue.

Overall, as investors scout for silver linings for IT stocks, it’s important to bear in mind that earnings upgrades hinge on meaningful revenue growth revival, which has been elusive so far.

 

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