Buy Wipro at Rs 538.6 and add on dips to Rs 470 - Rs 490 :: HDFC Securities

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In our Q3FY15 result review dated April 24, 2015, we recommended investors to buy Wipro at the then CMP of Rs. 606.3 and to add it on dips to Rs. 537-556 for a price target of Rs. 652 over the next quarter. Thereafter, the stock met our price target on Feb 13, 2015 and subsequently touched a new high of Rs. 676.9 on March 11, 2015 before correcting sharply to Rs. 512.6 on April 24, 2015. Currently it is quoting at Rs. 538.6. Wipro’s Q4FY15 numbers were below our estimates on the revenue front and at the operating level. However, PAT growth was above our projections. Muted Q-o-Q revenue growth in constant currency (CC), weakness in the energy and utilities vertical, soft growth across client brackets and muted USD revenue growth guidance for Q1FY16 were some of the negative highlights of the quarter. Given below are some of the key highlights, which we came across while reviewing the results. Key highlights of Q4FY15 results: (IT services and products)  Consolidated net revenues (INR) for the quarter increased by 4.2% Y-o-Y and by 1.2% Q-o-Q to Rs. 121.42 bn. In dollar terms, the IT services revenues de-grew by 1.2% Q-o-Q to USD 1774.5 mn, impacted by cross currency headwinds & weakness in energy and utility verticals. The Q-o-Q revenue growth in CC was at 1.2% Q-o-Q, which was near the lower end of guidance (1-3% Q-o-Q) given by the management. Further, the CC growth was lower than that reported by its peers HCL Tech & TCS (2.7% & 1.6% Q-o-Q respectively). In INR terms, the revenue grew by 1.2% Q-o-Q. IT services revenues in INR fell by 0.9% Q-o-Q, while IT products grew by 22.1% Q-o-Q (on a low base). IT Products revenues for FY14 included sales of Wipro branded desktops, laptops & servers which Wipro ceased manufacturing in Q3FY14.  Overall EBIT declined by 4.9% Y-o-Y, but increased by 2.2% Q-o-Q. EBIT margins declined by 192 bps Y-o-Y, but rose 18 bps Q-o-Q. Sequential rise in the margins despite cross currency headwinds was encouraging, led by higher utilization and cost control initiatives. Segment-wise, IT services business EBIT declined by 4.9% Y-oY, but rose 0.1% Q-o-Q, while the EBIT margins declined by 249 bps Y-o-Y, but rose 23 bps Q-o-Q to 22%, despite cross currency headwinds, led by higher utilization levels. The IT products business EBIT declined by 59.4% Y-o-Y & 34.8% Q-o-Q, while the segment EBIT margins fell by 68 bps Y-o-Y & 54 bps Q-o-Q to 0.6%.  PBT growth stood at 0.7% Y-o-Y & 3% Q-o-Q. Finance & Other income (net) grew by 46.4% Y-o-Y & 8% Q-o-Q. Effective tax rate declined by 111 bps Y-o-Y & 56 bps Q-oQ to 21.5%. Minority interest rose by 15.1% Y-o-Y & 40.8% Q-o-Q. PAT grew by 2% Y-o-Y & 3.6% Q-o-Q. PAT margins declined by 39 bps Y-o-Y, but rose 43 bps Q-o-Q to 18.7%. EPS for the quarter stood at Rs. 9.2 (on equity of Rs. 4937 mn) vs. Rs. 9 (on equity of Rs. 4932 mn) in Q4FY14 and Rs. 8.9 in Q3FY15 (on equity of Rs. 4937 mn).

Other highlights:  The management expects revenues from its IT Services business to be in the range of $ 1,765 mn to $ 1,793 mn in Q1FY16. The Guidance is based the following exchange rates: GBP/USD at 1.49, Euro/USD at 1.07, AUD/USD at 0.77, USD/INR at 62.10 and USD/CAD at 1.27. The company points out that weakness in Oil & Gas affected revenue growth for the company and prompted for muted revenue growth guidance for Q1FY16 (US$ revenue growth guidance of -0.5 to 1% on sequential basis). Besides, one of company's clients in BFSI vertical is depicting weakness, which company expects to impact Q1FY16 performance.  As per the management, the weakness in Oil & Gas industry would hamper revenue growth for Wipro in FY16; however the company expects vendor consolidation opportunities in market in second half of FY16. The management said that the deal pipeline is steady excluding Oil & Gas segment.  The company expects Healthcare, Manufacturing and Retail verticals to register strong revenue growth while Telecom vertical is expected to be adversely impacted due to cross currency headwinds given larger exposure to Europe. Outside the weakness in one of the BFSI client, the company guided for optimistic demand in BFSI vertical in FY16.  The management sees Digital, Open Source and Artificial Intelligence as key levers for driving business change and reshaping the delivery model for the future.  The company's Open Source practice continued to gain traction with customers in the areas of Middleware, Cloud, Analytics, Big Data, API (Application Program Interface) and Operating Systems across industries. Some marquee wins in Q4 include building treasury, budgeting, financial operations and MIS systems for a government organization, middleware integration for a global retail giant and migration of applications from a proprietary platform to an Open Source application server for a global investment bank.  Wipro's Cloud business continued to build significant momentum in the applications and infrastructure areas. The company has expanded its cloud applications business into new geographies with deal wins that include a leading Australian banking and insurance provider and a leading energy provider in Canada.  The company stated that it will roll out wage increments w.e.f Jun 01, 2015 and the wage revision will be in line with industry rates. The management indicated that margins in Q1FY16 would be impacted by wage hikes. Wipro targets to maintain margins in a narrow range in FY16. The management informed that it continues to maintain its focus on operational improvements and productivity enhancements.  Wipro declared final dividend of Rs. 7 per share, taking the total dividend for FY15 to Rs. 12 per share. This translates into dividend payout of 40%, including dividend tax in FY15 vs. 30% in FY14.  Rishad Premji has been appointed as the whole-time director of the company with effect from May 01, 2015.  The hedges for the quarter stood at USD 2.7 bn as vs. USD 2.2 bn in the previous quarter.  The cash and cash equivalent for the company stood at Rs. 15,894 cr vs. Rs. 12,211.3 cr reported in the previous quarter. Summary Wipro’s Q4FY15 numbers were below our estimates on the revenue front and at the operating level. However, PAT growth was above our projections. Muted Q-o-Q revenue growth in constant currency (CC), weakness in the energy and utilities vertical, soft growth across client brackets and muted USD revenue growth guidance for Q1FY16 were some of the negative highlights of the quarter. The Q-o-Q USD revenue growth was impacted by cross currency headwinds and weakness in Energy & Utilities verticals (led by weakness in oil & gas sector). The Q-o-Q revenue growth in CC was near the lower end of guidance given by the management and lower than that reported by its peers HCL Tech & TCS (2.7% & 1.6% Q-o-Q respectively). Weak growth in ADM reflected weakness in commoditized high-volume services. We were also concerned with the poor performance across key geographies Europe & US. The only silver lining was improvement in Q-o-Q EBIT margin witnessed during the quarter, led by improvement in utilization & cost control initiatives. This, coupled with lower effective tax rate aided the PAT growth. Attrition remained stable during the quarter (sequentially), which was another encouraging factor (though it is still at higher levels).

The Q-o-Q USD revenue growth guidance for Q1FY16 given by the management was muted & lower than our expectations. The weakness in the oil & gas sector (persisting over the last three quarters due to sharp fall in crude prices) and weakness in one of the clients in BFSI verticals has prompted the management to go for muted guidance. However, the management has highlighted steady deal pipeline excluding Oil & Gas segment and expects the recovery in execution in the coming quarters. It expects client specific weakness in BFS to resolve by Q2FY16 and expects strong revenue growth in Healthcare, Manufacturing and Retail verticals. While Wipro has hinted at recovery from Q2FY16, we feel it could face challenges in growth considering higher exposure to the Energy & Utilities vertical (~15.5% of total revenues), which is likely impact the growth in FY16. Healthcare and E&U are the only two verticals, which have consistently driven Wipro’s growth over the last few quarters. However, these verticals have started showing signs of weakness. For steady revenue growth, improvement in underperforming verticals like Manufacturing, Retail, Transport is essential. While the management expects strong growth in these verticals, we would closely monitor the same. Wage hikes and increased hiring could continue to put pressure on margins, though it would be partly offset by improvement in utilization levels. The weak start may impact the overall growth for full year FY16. Muted guidance for Q1FY16 and pressure on margins likely in the coming quarters further raises doubts on sustainability of revenue growth. Moreover, Industry lobby Nasscom has factored in weaker technology budgets and cut its software exports growth forecast from last year to 12-14% for FY16 (from 13-15% guided earlier). Also, worldwide IT spending is also expected to shrink by 1.3%, according to technology researcher Gartner. Hence we feel Wipro could fall short of our estimates in FY16. Hence we are downgrading our net revenue, operating profit & PAT estimates by 3.3%, 5.7% & 2.8% respectively. Accordingly, revised EPS is estimated at Rs. 37.3 (vs. original estimates of Rs. 38.3). We have incorporated projections for FY17, wherein we expect the net revenue, operating profit & PAT to grow by 9%, 10.1% & 9.6% respectively. EPS for FY17 is estimated at Rs. 40.8. At CMP, the stock is trading at 13.2xFY17E EPS, which is at a discount of ~26% to TCS. The discount to TCS is justified considering its relatively lower margins and lower success in driving incremental growth. Despite sharp correction in the stock price post disappointing Q4FY15 results and weak guidance for Q1FY16, the stock price upside is likely to be capped. For better valuations, the company will have to impress the street with robust numbers in the coming quarters. Valuing the stock at 14xFY17E EPS, we arrive at a price target of Rs. 572. We recommend investors to buy this stock at current levels and to add it on dips to Rs. 490-470 (11.5-12.0xFY17E EPS) for our price target over the next quarter.

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