HCL Tech puts IT investors on edge

Just two months ago, post the September quarter earnings (Q2FY23), HCL had raised its FY23 constant currency revenue growth forecast to 13.5-14.5% from 12-14% earlier. The revised guidance that time, along with better Q2 earnings, had boosted sentiments for the stock, leading to a nearly 16% rise since last quarter’s earnings and before Friday’s fall.

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It’s worth noting here that HCL hasn’t said it will miss its FY23 guidance. “That’s encouraging,” said Amit Chandra, institutional research analyst, IT, HDFC Securities. Amid weak markets, bogged down by HCL’s shares, the Nifty IT index fell by 3% on Friday. Before this, the index had risen by 8.6% in the past two months thanks to better-than-expected Q2 earnings before interest and tax (Ebit) margin performance of IT companies.

“IT stocks have rallied after the end of Q2 results season, but investors could now be worried about the sudden change of expectations on how growth for the sector will pan out in the foreseeable future. Even so, it is worth noting that furloughs are an industry-wide occurrence in Q3, and it’s likely that other IT companies, too, would face this. The initial reaction to HCL’s commentary on the revenue guidance appears to be knee-jerk,” says Chandra.

While announcing Q2 earnings, HCL toned down its FY23 margin guidance from the 18-20% range to 18-19%. Last week, the company retained its latest FY23 margin guidance. “HCL now aspires to reach the top-end of its margin guidance of 18-19%, which is a back-to-back increase in margin guidance,” according to a Nuvama Research report dated 9 December. After Q1 results, HCL had guided to end FY23 within the Ebit margin range (18-20% that time) albeit towards the lower end of the range. “HCL’s guidance for FY23 has remained volatile for both revenue and margins. We believe this should not be read as an industry-wide slowdown given the volatile nature of HCL’s guidance,” said Nuvama’s analysts.

That said, there are brokerages at the other end of the spectrum who caution that this could well be the tip of the iceberg, and the Indian IT industry might see challenging times ahead.

Clearly, in an already gloomy scenario, this is not helping investors. However, expectations are that more clarity on industry trends will emerge after global IT giant Accenture announces its Q1FY23 (quarter ended November) results this week. Accenture’s results are often seen as a barometer of the performance of the Indian IT sector.

But as things stand, there is uncertainty on how the demand environment would pan out in FY24. To be sure, investors seemed to have acknowledged this. The Nifty IT index has fallen by 24.6% so far in CY22. Valuations of IT firms have cooled off meaningfully from their highs, but they remain higher compared to long-term averages. “Currently, shares of tier-1 IT stocks are trading at a premium of only 12% versus the ten-year average price-to-earnings (PE) multiples. In comparison, tier-2 IT stocks are at a higher premium of 30% versus the 10-year average PE multiples,” Chandra said. As such, triggers for meaningful near-term upsides appear few and far between for now.