Hold : Wipro for a target of Rs 595

(BSE: 507685 | NSE: WIPRO | ISIN: INE075A01022)

Revenues in line but margins take a hit : Wipro’s Q1FY08 revenues grew in line with expectations. Dollar revenues rose 5.1% QoQ to US$ 726mn, ahead of the company’s guidance of US$ 711mn. Disappointingly however, the company witnessed margin pressure during the quarter despite the absence of salary hikes and a significant increase in utilisation rates. With offshore and onsite salary hikes coming in during Q2 and Q4, we expect the margins to remain subdued going forward. We project a YoY decline of 130bps in the operating profit margin, and have hence revised our estimates and target price downwards and moved to a Hold rating on the scrip.

Revenue growth : As expected, revenue growth for the quarter remained muted with the Global IT business recording a1.1% QoQdecline. Consolidated revenues dipped 3.5% as against Q4FY07 as the first quarter is seasonally the weakest for the Asia-Pac IT business while the fourth quarter is the strongest.

Operating profit margins : Despite the absence of salary hikes during the quarter, the consolidated operating profit margin (OPM) declined by 250bps to 16.4% as compared to 18.9% in Q4FY07. The OPM in the Global IT business stood at 20.9%, a drop of 330bps QoQ. The BPO business logged a margin of 22.2%, reflecting a relatively lower decline of 280bps despite rupee appreciation.

Q2FY08 revenue guidance : The management expects Q2FY08 revenues of US$ 777mn from Global IT services, a sequential growth of 7%. Seasonally, Q2 and Q3 are the strongest quarters for the company.

Effort mix : During Q1FY08, the onsite and offshore volumes have increased by 6.9% and 6.3% QoQ respectively.

Pricing : Pricing remained stable for offshore services whereas onsite pricing has shown a dip of 1.4% QoQ. For the past few quarters, Wipro has lagged behind industry peers in terms of pricing improvement.

Onsite-Offshore : The onsite-offshore revenue mix remained stable during the quarter.

Employee addition : The company has added 4,319 employees (net) during the quarter of which 2,719 employees were added in the IT Services & Products business and 1,600 in the BPO segment.

Attrition rate : Attrition in the IT services business has increased to 20.1% during the quarter from 16.9% in the previous quarter. This is a key area of concern, which the company has to remedy, going ahead.

Salary hikes : Wipro has brought forward its Q2 offshore salary hikes from September to August, and these are expected to be in the range of 12-13%; onsite wage hikes will be given in Q4.

Clients additions : The company added 39 new customers during the quarter. Total active clients stood at 647 with 126 clients contributing over US$ 1mn in annual revenues and 10 clients contributing more than US $50mn in revenues. The top 10 customers grew at 3.2%, slower than the 5.5% growth rate of other clients.

Geographical mix : The US has grown at a faster rate than the other geographies, contributing ~65% of revenues as compared to 63.8% in Q4FY07. The share of Europe has decreased from 31.1% in Q4FY07 to 30.7% in Q1FY08.

Utilisation Levels : Net utilisation has improved by 550bps over Q4FY07 to 67%. This has helped the company to offset the impact of rupee appreciation on margins. The gross utilisation rate improved from 64% in Q4FY07 to 67% in Q1FY08.

Services metrics : No major trend change was seen in the services mix. BPO and Package implementation continued to witness strong growth, whereas the contribution from Infrastructure services and Testing services remained flat.

Vertical metrics : Product engineering services continued to witness slower-than-average growth. The revenue share from this vertical decreased to 32.8% in Q1FY08 from 33.1%in Q4FY07. Growth in the financial services vertical was back
on track.

Future outlook : Growth pace to lag behind industry peers We maintain our view that Wipro’s pace of growth would lag behind that of industry peers due to the declining contribution from key verticals like product engineering services. Though we expect the demand in this vertical to turnaround and increase in the later part of FY08, the growth momentum would take 3-4 quarters to fully recover. In dollar terms, we expect Wipro’s Global IT business to record revenues of US$ 3,179mn in FY08 and US$ 3,971mn in FY09, a YoY growth of 30.4% and 24.9% respectively. The growth in rupee terms would be lower at 18% and 22.9% in FY08 and FY09 respectively. We expect the FY08 profit margins to remain under pressure due to salary hikes in Q2 and Q4, and decline by 130bps as compared to the 20% margin in FY07.

We are revising our estimates downwards We are reducing our FY08 and FY09 estimates by 1-5%. We now expect EPS for the two years to be at Rs 22.8 and Rs 27.1, which is lower than our earlier estimates by 3.8% and 5.5% respectively.

Valuation : Target lowered to Rs 595 We are revising our target price for Wipro from Rs 659 to Rs 595. The price factors in the revision of estimates as well as realignment of our P/E multiples for the sector. We value Wipro at 22x its FY09 expected earnings, which is a discount of ~8% and ~4% to our target multiples of 24x and 23x for Infosys and TCS respectively. Downgrade to Hold We believe the discount to these peers would continue due to lower growth rates anticipated in FY08 and FY09. In the last six months, Wipro has been an under- performer as compared to its peers and has also seen a level of de-rating in its valuations. We recommend that investors Hold the stock.

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Investment in equity shares has its own risks. Sincere efforts have been made to present the right investment perspective.The information contained herein is based on analysis and up on sources that we consider reliable. I, however, do not vouch for the accuracy or the completeness thereof. This material is for personal information and I am not responsible for any loss incurred based upon it.& take no responsibility whatsoever for any financial profits or loss which may arise from the recommendations given in this blog.