Shares of HCL Technologies have returned 59 per cent since January and 28 per cent since April. It put up a strong show over several quarters, as it went after the deal renewal market. India's fourth largest technology company grew consolidated net profit by 48 per cent and revenues by 31 per cent in FY12 (financial year ended June).
Now, the market is asking if this outperformance is likely to continue. Consensus estimates are not as optimistic on revenue growth now in February. Bloomberg consensus revenue estimates have come down from 18 per cent year-on-year growth in February to 10 per cent now. Analysts say HCL Tech's growth in recent times was due to a strategic focus on the deal renewal market. Typically, that's a space where the big boys of IT were not interested, as the existing vendor would retain 80 per cent of the business and the rest would be won by smaller players. Given that new deals are difficult to come by, even the bigger players are going after the deal renewal market. Heightened competition indicates revenue growth will come under pressure.
Despite expectations of 13-14 per cent revenue growth in FY13 and FY14, the market's view on the stock remains optimistic. Over the last few years, it has been seen that the company's revenue growth is inversely correlated to margins. HCL's revenue growth may have now hit a bottom. But margins might continue to trend higher, is the perception. However, Espirito Santo believes that in order to drive revenue growth from here, HCL will have to give away margin. The brokerage says the company will need to reinvest in the business to improve revenue growth rates. As a result, it is modelling earnings before interest, taxes, depreciation and amortisation margins of 21 per cent in FY13 and 19.5 per cent in FY14. The brokerage believes these are best-case margins. The company has seen a margin improvement of 510 basis points since the first quarter, but nearly 480 basis points have been driven by the rupee depreciation, which could well reverse.
The outlook on margins is challenging for HCL as well as other larger players. Kotak Institutional Equities says no Tier-I companies have margins of over 30 per cent. Despite the currency appreciation, big companies have failed to show material improvement in margins. So, leading brokerages are cautious on Tier-I companies. FY14 might see muted revenue and earnings growth for most IT companies.