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Demand stress test ahead
Downgrade to REDUCE, significant risk to Street FY13-14 EPS
Demand likely to deteriorate by late FY12, cut FY13E EPS by 24%
Turnaround running behind schedule, macro adds more stress
Heightened risk aversion could lead to de-rating of valuation
Downgrade to REDUCE
We downgrade Wipro to REDUCE (from
Buy) and the India IT services sector
outlook to DETERIORATING. Despite the
stock declining by 11% in August alone
(vs a 7% drop of the Sensex), we think it
is yet to reflect a likely prolonged anaemic
macro growth scenario and 50% chance
of a US recession that our economics
team forecasts. We cut our FY12-13
revenue estimates by 3-15% based on
our expectation that demand will worsen
around the December 2011 quarter.
Moreover, we believe some of the
revenue cuts will be led a loss of pricing
and we see Wipro’s already lower-than-peer EBIT margins going down
further, leading to a significant EPS downgrade. Our FY12-13 EPS
estimates reduce by 8-24% and are 5-15% below Bloomberg consensus.
Weaker demand scenario will test turnaround plans
While we have been hopeful of an operational turnaround by 2HFY12
after management and organisational changes earlier this year, we are
yet to see enough positive signs that should have surfaced by this time.
Among the positives are an increase in the USD100m+ accounts from
one in 3QFY11 to four in 1QFY12 and a likely decline in employee
attrition to sub-20% by 2QFY12, from 25% in 1Q. However, of the
company identified “momentum verticals” (together 64% of revenue), only
energy & utilities (+14.4% q-q) was strong in 1Q, while financial services
(+0.5% q-q), retail (-3.6% q-q) and healthcare (-3.2% q-q) are yet to show
the promise we were hoping for. Also, the 2QFY12 q-q services revenue
growth guidance of 2-4% (0-2% organic) which was given under more
“normal” demand conditions looks muted and suggests there is still much
more to be done before Wipro matches peer growth levels. We believe a
worsened demand scenario could further test the turnaround plans.
Valuation and target price derivation
Given heightened macro uncertainty and risk aversion, we expect stocks
to trade significantly below the level implied by our DCF model based on
long-term average risk assumptions. In 2008, large-cap Indian IT stocks
fell as much as 40-65% below our fair value estimates, so we set our TP
for Wipro at a 25% discount to our DCF value of INR270.00 (from
INR530.00). Our new TPs for Wipro implies an FY13E P/E multiple of
11.9x. Key risks to TP are: 1) unexpected USD/INR depreciation (as
seen in 2008-09) that negates our EPS cuts, and 2) less-than-expected
deterioration of the macro environment.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Demand stress test ahead
Downgrade to REDUCE, significant risk to Street FY13-14 EPS
Demand likely to deteriorate by late FY12, cut FY13E EPS by 24%
Turnaround running behind schedule, macro adds more stress
Heightened risk aversion could lead to de-rating of valuation
Downgrade to REDUCE
We downgrade Wipro to REDUCE (from
Buy) and the India IT services sector
outlook to DETERIORATING. Despite the
stock declining by 11% in August alone
(vs a 7% drop of the Sensex), we think it
is yet to reflect a likely prolonged anaemic
macro growth scenario and 50% chance
of a US recession that our economics
team forecasts. We cut our FY12-13
revenue estimates by 3-15% based on
our expectation that demand will worsen
around the December 2011 quarter.
Moreover, we believe some of the
revenue cuts will be led a loss of pricing
and we see Wipro’s already lower-than-peer EBIT margins going down
further, leading to a significant EPS downgrade. Our FY12-13 EPS
estimates reduce by 8-24% and are 5-15% below Bloomberg consensus.
Weaker demand scenario will test turnaround plans
While we have been hopeful of an operational turnaround by 2HFY12
after management and organisational changes earlier this year, we are
yet to see enough positive signs that should have surfaced by this time.
Among the positives are an increase in the USD100m+ accounts from
one in 3QFY11 to four in 1QFY12 and a likely decline in employee
attrition to sub-20% by 2QFY12, from 25% in 1Q. However, of the
company identified “momentum verticals” (together 64% of revenue), only
energy & utilities (+14.4% q-q) was strong in 1Q, while financial services
(+0.5% q-q), retail (-3.6% q-q) and healthcare (-3.2% q-q) are yet to show
the promise we were hoping for. Also, the 2QFY12 q-q services revenue
growth guidance of 2-4% (0-2% organic) which was given under more
“normal” demand conditions looks muted and suggests there is still much
more to be done before Wipro matches peer growth levels. We believe a
worsened demand scenario could further test the turnaround plans.
Valuation and target price derivation
Given heightened macro uncertainty and risk aversion, we expect stocks
to trade significantly below the level implied by our DCF model based on
long-term average risk assumptions. In 2008, large-cap Indian IT stocks
fell as much as 40-65% below our fair value estimates, so we set our TP
for Wipro at a 25% discount to our DCF value of INR270.00 (from
INR530.00). Our new TPs for Wipro implies an FY13E P/E multiple of
11.9x. Key risks to TP are: 1) unexpected USD/INR depreciation (as
seen in 2008-09) that negates our EPS cuts, and 2) less-than-expected
deterioration of the macro environment.
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