WIPRO:: Mellow quarter in a buoyant environment :: Edelweiss

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􀂃 Reported results in line with estimates; margins disappoint
Wipro’s Q2FY11 revenues and net profits, though in line with estimates, lagged
growth reported by large peers. Global IT revenues, at USD 1,273, grew a
modest 5.7% Q-o-Q, while operating margins declined 240bps to 22.2%.
Promotions, RSU charges and foreign currency impacted margin performance for
the quarter. Net profit was reported at INR 12.85bn, down 2.5% Q-o-Q and up
9.8% Y-o-Y. Further, the next quarter (Q3FY11) constant currency revenue
growth guidance, at 3.5-5.5%, seems a tad lower.
􀂃 Top clients’ performance continues to cause concern
Key account management and client mining cause concern, with Wipro lacking
the ability to convert large client engagements to the order of USD 100 mn+.
This partly explains the company’s underperformance against peers. Wipro has
425 USD 1 mn+ clients (higher than 337 for Infosys), however comparison on
clients in the USD 50mn+ and USD 100mn reverses with Wipro have 60 (USD
50mn+) and 1 (USD 100+) client compared to 66 and 8 for Infosys. This is the
single biggest issue vexing the management. Top 10 clients grew meager 2.5%
Q-o-Q and top 2-5 only 3.1% (8.4% Y-o-Y). The CEM structure is clearly taking
longer to yield results.
􀂃 Continued underperformance vis-à-vis peers: A key disappointment
Over the past four quarters, Wipro has continued to underperform on volume
growth compared with large peers (see Chart 1 on the next page). This is
essentially explained by the company’s lower-than-peer exposure to US and
BFSI (see Chart 2 & 3) that has been driving most of the incremental growth.
􀂃 Margins to increase marginally in future
Optimizing the supply chain by keeping a leaner bench and bringing in process
suites along, pricing improvement and forex (due to cash flow hedge accounting
followed) will aid operating margins. However, RSU charges and strong rupee
could restrict majority of the margin improvement. We see EBITDA margins for
global IT improving to 24.5% for FY12 (vis-à-vis 23.3% witnessed in H1).
􀂃 Outlook and valuations: Discount to continue; downgrade to ‘HOLD’
Wipro is currently trading at P/E of 20.6x and 17.7x FY11E and FY12E earnings.
This is at 18% discount to TCS’ valuations, which we see continuing given
Wipro’s moderate growth outlook and slow pace of margin improvement, going
forward. We, thus, downgrade the stock to ‘HOLD’ from ‘BUY’ and rate it
‘Sector Underperformer’ on relative basis.