India Equity Research: Accumulate Wipro – 3QFY2011 Result Update

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Wipro – 3QFY2011 Result Update

Angel Broking maintains an Accumulate on Wipro with a Target Price of Rs. 507.

For 3QFY2011, Wipro reported lower-than-expected numbers. The IT services

segment posted revenue of US $1,344mn (v/s our expectation of US $1,350mn),

up 5.6% qoq. The 4QFY2011 revenue guidance of US $1.38bn–1.41bn for this

segment lacks lustre, with qoq growth of 3–5%. Wipro continues to lag its peers

and with new organisational restructuring at the top end, we expect volumes to

remain tepid. Thus, we continue to maintain Accumulate on the stock.

Muted growth: For 3QFY2011, Wipro registered dismal 1.3% qoq growth in

revenue to `7,829cr v/s our estimate of `7,972cr. This muted performance came

on the back of subdued volume growth of 1.5% qoq in the global IT services

segment, a 13.1% yoy dip in the IT products segment and lower exchange rate

realisations due to a 3.5% qoq INR appreciation against USD in 3QFY2011.

Margins inch up: EBIT margin increased by 18bp qoq to 18.3% as the proportion

of the low-margin IT products business declined by 260bp qoq to 11.2% and

margins for IT services stayed at 22%.

Outlook and valuation: Wipro continues to be a laggard in the tier-I IT pack

because of its high exposure to the telecom, media and technology verticals (25%

of revenue). Over FY2010–12E, we expect the IT services segment to post a

19.4% CAGR (USD) and 16.5% CAGR (INR) in revenue due to lower exchange

realisations on account of out-of-the-money cash flow hedges than spot.

We expect the consumer care and lightening segment and the IT products

segment to log revenue CAGR of 21.1% and 2.8% over FY2010–12E,

respectively. We recommend Accumulate on the stock with a Target Price of `507,

valuing it at 21x FY2012E EPS of `24.2

Muted revenue growth in IT services continues

For 3QFY2011, Wipro posted disappointing performance. The company continues

to lag tier-I IT companies in terms of volume growth. The company’s IT services

segment reported revenue of US $1,344mn (v/s our expectation of US $1,350mn),

up 5.6% qoq. Volume growth for the IT services segment was highly muted at

1.5%, while peers logged 3–7% volume growth during the quarter. Management

indicated that some contract signing got delayed during the quarter, which also

negatively affected volume growth; however, those contracts are not cancelled.

In constant currency (CC) terms, the IT services segment’s revenue came in at

US $1,325mn, up 4.1% qoq.

Volume growth of 1.5% qoq came on the back of merely 0.5% qoq offshore and

4% qoq onsite volume growth during the quarter.

Wipro managed to garner better price points offshore with 2.5% qoq growth (CC

terms); however, onsite pricing declined by 0.8% qoq (CC terms). The decline in

onsite pricing was due to a larger number of customer closure days onsite due to

the holiday season. On a reported basis, the company reported qoq pricing

growth of 0.6% and 3.7% for onsite and offshore, respectively.

Wipro witnessed double-digit growth in consulting services (contributing 3.1% to

revenue) of 14.4% qoq. Service verticals such as application development and

maintenance (ADM – contributing 40.3% to revenue) and technology infrastructure

services (contributing 21.4% to revenue) showed good growth momentum with

9.5% and 6.6% qoq growth, respectively. Other service verticals such as package

implementation (contributing 13.2% to revenue), testing services (contributing

11.0% to revenue) and BPO (contributing 9.3% to revenue) reported subdued

growth of 2.3%, 1.8% and 0.1% qoq, respectively. However, in the product

engineering services vertical, Wipro reported a 1.0% qoq decline, unlike its peers

that posted 4–7% qoq growth in this vertical and are witnessing good traction as

clients have started spending on new product innovations to garner higher market

share due to higher consumer spending.

Wipro witnessed growth in most of its industry segments, but it was not

broad-based like peers. The company registered a 4.0% qoq decline (CC terms) in

the technology segment (contributing 7.5% to revenue), bringing down its

contribution by 70bp qoq to 7.5%. The segment’s revenue is mostly driven by the

US market. In the healthcare and service segment (contributing 8.0% to revenue)

also, Wipro reported a decline of 4.8% qoq (CC terms), unlike its peers that are

witnessing good traction in this vertical, posting 7–9% qoq growth. Further, going

ahead, Wipro has a strong deal pipeline in this segment, mostly in the ITO and

BPO service verticals. The company’s anchor segment, financial services

(contributing 27.3% to revenue), posted robust 6.1% qoq growth (CC terms). This

segment is witnessing strong growth in the US and APAC region for work related to

core banking, compliance issues, regulatory issues and security. The energy and

utilities segment (contributing 9.9% to revenue) came as the company’s primary

growth driver, posting whopping 13.1% qoq growth (CC terms) and good traction

is seen in this vertical going ahead in businesses relating to oil and gas, smart grid

and safety, among others, mostly for cost-cutting measures. Other segments such

as CMSP (contributing 8.8% to revenue), manufacturing (contributing 14.9% to

revenue) and retail and transportation (contributing 15.4% to revenue) reported

modest growth of 4.2%, 5.3% and 3.5% qoq (CC terms), respectively, during the

quarter. Revenue from the telecom segment (contributing 8.2% to revenue) came

as a positive surprise, growing by 4.3% qoq (CC terms) as against its peers that

reported a decline in this segment during the quarter.

Wipro reported strong 9.7% qoq growth (CC terms) in revenue from Europe,

outperforming its peers that remained laggard. Industry segments such as

manufacturing, financial services and energy and utilities are having good traction

from Europe. However, America, Japan and India and Middle East posted muted

growth of 2.4%, 3.5% and 2.6% qoq (CC terms), respectively. On the other hand,

the APAC region and other emerging markets declined by 1.1% qoq (CC terms);

however, the company is observing continuous growth in these markets going

ahead.

Segmental performance

During the quarter, the IT services segment’s revenue came in at US $1,344mn, up

5.6% qoq, with India and Middle East business being the major driver, posting

14.1% qoq growth with revenue coming at US $244mn. Revenue from the global

IT and BPO businesses came in at US $995mn and US $125mn, up 4.5% and

0.2% qoq, respectively.

Since the last couple of quarters, the global IT business has been the major growth

driver for the company’s IT services; but, in 3QFY2011, the global IT business

posted highly muted volume growth of 1.5%. The IT services segment benefited

1.4% from cross-currency movement derived due to USD depreciation of 1.9%,

5.1% and 9.1% qoq as against the GBP, Euro and AUD, respectively.

The IT products segment’s revenue declined by 13.1% yoy to `879cr, as 3Q is a

seasonally weak quarter for this business, dragging overall consolidated sales of

the company. The segment’s revenue mostly came from India and the Middle East

region, where growth was muted.

The consumer care and lightening segment continued its growth momentum with

Yardely bolstering growth along with Deos. Revenue came in at `695cr, reporting

whopping 21.0% yoy growth. In the lightening business, Wipro is gaining traction

in its eco energy business, which involves managing energy through use of

renewable products. The company has lighted 70 green buildings, out of 125

government declared green buildings. Moreover, out of 25 platinum green

buildings, the company has lighted 17 buildings.

On a consolidated level, revenue came in at `7,829cr (v/s our expectation of

`7,972cr), reporting mere growth of 1.3% qoq.

Margins inch up

EBIT margin for IT services came in flat qoq at 22.2%, while EBIT margin for the IT

products and consumer care segments declined by 35bp and 21bp qoq to 4.6%

and 12.3%, respectively. Overall, EBITDA and EBIT margins increased by 29bp

and 18bp qoq to 21.0% and 18.3%, respectively, as proportion of the low-margin

IT products business declined by 260bp qoq to 11.2%.

Client pyramid

Wipro added 36 new clients in 3QFY2011, 15 from the US, nine from India and

Middle East and the rest six from Europe. Out of the total new clients, nine each

were added in the retail and transportation and energy and utilities segments,

seven in the healthcare segment and six in the manufacturing segment. However,

the active client base decreased to 880 in 3QFY2011 from 890 in 2QFY2011.

Wipro’s client pyramid witnessed qualitative improvement, with many clients

moving from lower brackets of US $1mn–3mn and US $3mn–5mn to higher

brackets of US $5mn–10mn and US $10mn–20mn. The client base of the

US $75mn–100mn bracket increased by one client.

Poor hiring and weak utilisations

Net additions during the quarter were decent at 3,591 employees, taking the total

employee base to 1,19,491. Utilisation rate of the global IT business slipped by

230bp qoq to 68.6%, the lowest level since the last seven quarters.

Voluntary attritions (annualised) declined to 21.6% from 23.5% in 2QFY2011.

4QFY2011 guidance muted

The 4QFY2011 revenue guidance of US $1.38bn–1.41bn for this segment lacks

lustre, with qoq growth of 3–5%, which points to subdued outlook for Wipro.

Management churn

During the quarter, a significant change in management took place. Mr. Suresh

Vaswani and Mr. Girish Paranjpe, the Joint CEOs of the company, stepped down

from their position. Mr. T.K. Kurien will be taking over as CEO, effective February

1, 2011, thus replacing the Joint CEO structure.

Outlook and valuation

Wipro continues to be a laggard in the tier-I IT pack because of its high exposure

to the telecom, media and technology verticals (24.5% of revenue). Pertinently,

other tier-I companies are witnessing broad-based and strong growth across

clients. Going forward, we expect the company’s underperformance on the volume

front to persist because of its client portfolio, which lacks an upbeat outlook, as per

the muted guidance of 3–5% qoq for the IT services segment, while the company’s

peers have an upbeat outlook.

We expect the IT services segment’s USD revenue to log a 19.4% CAGR and INR

revenue to log a 16.5% CAGR (lower growth as against USD revenue due to lower

exchange realisations on account of out-of-the-money cash flow hedges than spot)

over FY2010–12E. Among the other segments, we expect the consumer care and

lightening segment to register a 21.1% CAGR and the IT products segment to post

a CAGR of 2.8% over FY2010–12E in revenue.

Going ahead, we believe Wipro will be able to absorb incremental impact of grant

of RSUs on the back of margin levers such as lower general and administration

expense and abating attrition helping utilisations. We expect EBITDA and PAT to

post CAGR of 15.2% and 13.6% over FY2010–12, respectively.

On the valuation front, at current levels, the stock is trading at 18.9x FY2012E EPS

of `24.2. We maintain Accumulate on the stock with a Target Price of `507,

valuing it at 21x FY2012E EPS.Voluntary attritions (annualised) declined to 21.6% from 23.5% in 2QFY2011.