Standard Chartered:: Wipro - Turning a new leaf, once again

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Wipro - Turning a new leaf, once again

 3Q11 revenues/PAT met our estimates
 More importantly, Wipro replaced the jointCEOs/structure with T K Kurien, a 10-year Wipro
veteran. We expect follow-on mid-management changes
as well as a course correction
 However, we expect minimal near-term impact of
transition. 4Q11 3-5% US$ revenue guidance supports
this
 We retain our forecasts and OUTPERFORM rating
3Q11: Revenue and PAT in-line; EBITDA marginally
below estimates. Combined IT services revenue grew
5.6% qoq to US$1.34bn, in line with our estimates, driven
by 4.7% blended realization growth in Global IT.
India/Middle-East grew 5.6% qoq while BPO revenues
were flat. Combined IT EBITDA margin was down 30bp
qoq to 25% (vs our 25.5% est), mainly due to slower
volume growth (1.5% qoq vs 6.2% est.). Higher other
income (Rs1.5bn) pushed PAT 2.6% qoq to Rs13.2bn.
Growth profile a conundrum; we do not expect a
repeat. We were surprised by the strong 2.5% qoq growth
in offshore realization (in constant currency) in a seasonally
weak quarter. We believe it was driven less by pricing
improvement and more by productivity gains (fixed-priced
projects revenue share up 2.3% qoq; ADM share up 1.5%).
We do not see the trend continuing and expect the 3-5%
4Q11 guided revenues to be volume driven.
Supply pressures appear to be easing; should help
mid-range margins. We believe staffing rationalization
kept the attrition high – 1% change in quarterly annualized
attrition (with 0.7% qoq rise in involuntary attrition) versus
3-4% reported by peers. However, we see no adverse
impact; wage hike has been pushed to 1Q12 from Feb-
2011 and utilization is at 7 quarter low.
Management changes a long-range positive. TK Kurien
was key in Wipro’s BPO business turnaround (25%
revenue CAGR with 12%+ EBITDA margin expansion
despite a 10% INR appreciation over FY06-08). We expect
follow-on changes on both demand and execution sides.
But we see few near-term triggers to close valuation
gap versus peers. We retain our FY11/12 EPS estimates
and P/E-based price target. We see minimal change to
current (15-20%) P/E valuation gap vs. peers. 3Q volume
underperformance will likely weigh on the stock near-term
even as investors await articulation of new management’s
focus.

OUTPERFORM maintained
We retain our long-range demand outlook build on the US$23bn addressable market
opportunity from the US$200bn+ renewal deal pipeline. We marginally lower our FY11/12
EPS forecasts by 0.8/1.1%, on account of marginally lower revenue growth and margin
assumptions. We reiterate our OUTPERFORM recommendation and price target of Rs510.
We retain our long-range demand outlook build on the US$23bn addressable market opportunity
from the US$200bn+ renewal deal pipeline. (see our note: IT Services – Dribbling into the big
league dated 16 December 2010). We broadly retain our 22% FY10-13 US$ revenue CAGR
forecasts. We have marginally lowered our IT services revenue growth assumptions and now
expect greater contribution from realization growth. Our margin outlook for IT services factors in
greater pressures from continued high attrition for Wipro. Downward revisions to our revenue and
margin assumptions for the non-IT businesses reflect pressures of stagnant growth and a high
inflation environment. Resultantly, we lower our FY11/12 EPS forecasts by 0.8/1.1%.


Reiterate OUTPERFORM rating at a price target of Rs510
We maintain our price target of Rs510 on Wipro, valuing the stock at 1.2xPEG at the upper end
of its historical trading band (0.8x-1.2x), on a FY10-13 EPS CAGR of 15.3%. The implied
valuation at 18.5x 12-month forward EPS is at a discount of 12% to Infosys. We see minimal
change to current (15-20%) P/E valuation gap vs. peers. 3Q volume underperformance will likely
weigh on the stock near-term even as investors await articulation of new management’s focus.


Risks to our estimates and price target
Key downside risks to our price target are: 1) rupee appreciation beyond the levels we assume
and/or adverse cross-currency movements; 2) a slower than anticipated pricing recovery; 3)
delays in the implementation of direct tax code beyond FY12; and 4) strong regulatory action
against outsourcing in Wipro’ key geographic markets.
Upside could come from: 1) rupee appreciation slower than the level we assume; 2) faster-than
anticipated recovery in project awards/ramp-ups; large-deal wins ahead of numbers or contract
value factored into our estimates; and 3) acquisitions/large deal wins not built into our model.