Shrinking margin leaves HCLTech stock with no room for error

HCL Technologies Ltd’s sequential margin contraction in the June quarter (Q1FY26) comes as a rude shock, even though the first quarter of a financial year is typically weak for the company owing to seasonality in its software business.Earnings before interest and tax (Ebit) marginfell 170 basis points (bps)to 16.3%, missingthe consensus estimate of 17.3%. What gives? Higher sales and marketing investments, lower utilisation, client bankruptcy shrunk Q1 margin. The upshot is that HCL trimmed its FY26 Ebit margin guidance band by 100 bps from 18- 19% to 17-18%. This unexpected outcome meant investors dragged the stock down about 3% on Tuesday. “One potential conclusion that the Street may draw is that HCL is trading off margins for revenue growth. This perception is reinforced by the downward revision of its Ebit margin guidance band—from 19-20% in FY22 to 17-18% for FY26, marking the second cut in four years," said a Kotak Institutional Equities report dated 14 July.A part of the margin decline is due to industry-wide pressure and may not return unless demand returns to normalcy or the Indian rupee depreciates significantly, Kotak cautioned. HCL’srevised margin guidance accounts for Q1’s lower utilisation levels to possibly continue in Q2. It also accounts for investments in sales and marketing and AI capabilities to boost growth, as well as the impact from the restructuring programme HCL plans to undertake this year. The company expects margin to normalise in FY27. Earnings downgrades Still, all this has not stopped earnings downgrades.“The weak margin in Q1FY26 and the guidance cut leave HCL with almost zero earnings per share (EPS) growth in FY26," said a Nuvama Research report on 14 July. It has cut its FY26 and FY26 earnings per share estimated by 5.7% and 3.1%, respectively. HCL’s Q1FY26 constant currency (CC) revenue was down 0.8% sequentially. Here, it outpacedlarger peer Tata Consultancy Services (TCS), which saw CC revenue fall 3.3% sequentially. The total contract value (TCV) of HCL's new deals declined to an eight-quarter low of $1.8 billion in Q1FY26 from $3 billion in Q4FY25. Delayed signing of deals and a large vendor consolidation deal slipping into from Q1 to Q2 led to this decline.Unlike TCS, the HCL management is confident of a stable demand environment and expects pick-up in deal TCV in Q2FY26. In effect,HCL raised the lower band of its FY26 CC revenue growth guidance from 2%-5% to 3%-5%. Also Read | Avenue Supermarts Q1: More of the same amid clouds of competition and high costs “In our view, the implied revenue CQGR (compound quarterly growth rate) is in the range of 1.4-2.7% for the lower and upper ends of revenue growth guidance for FY26E, which is not challenging, considering deals ramp up from Q2 as well as Q3 seasonality," said an Elara Securities (India) report dated 15 July. Financial services and technology verticals showed resilience, but softness persisted in manufacturing (particularly auto), life sciences, retail, and consumer packaged goods.Still, the deal pipeline is robust and clients continue to prioritise AI-led efficiency and transformation projects, management said. HCL stock has recovered 13% from its 52-week low of Rs1,302.75 on 7 April. TCS’s shares have been flat and those of Infosys Ltd are up 14% over this period. HCL stock trades at 22 times estimated FY27 earnings, showed Bloomberg data. The valuation multiple is largely in line with those of TCS and Infosys. While HCL has the potential to beat its peers on organic revenue growth in FY26, after the margin blip, the stock's valuation leaves no room for disappointment. Also Read | Sobha Ltd eyes big FY26 comeback with launches beyond Bengaluru