Wipro rating: Hold — Growth outlook remains uncertain, especially in near term

Employees work at a laptop computer at the Wipro Ltd. headquarters in Bangalore, India, on Thursday, April 14, 2016. (Image: Bloomberg)

Wipro’s Q1FY21 results were a further reinforcement of our theory of the operating resilience of the IT sector in a weak demand environment. The company reported more than a 7% decline in revenues for Q1 (not much different from TCS) but still expanded margins significantly by ~150bps q-o-q (IT services). However, its growth outlook remains uncertain, especially in the near term. The strategy of the new CEO is still a work in progress, and we await hearing more on his go-to-market strategy.

The key issue for Wipro remains clientmining, in our view, and the new CEO’s strategy to address this weakness will likely be keenly observed. In the near term, management remained confident on margin sustenance but was not committal on a growth recovery (for Q2 or beyond).

Q1FY21 highlights

Margin expansion was led by the nearly 100bps benefit from operational efficiencies (lower variable employees, automation and better utilisation); favourable currency (nearly 100bps); lower travel costs; and decrease in variable employees. While some costs are likely to bounce back, management seemed confident of maintaining them in a narrow band. Bad debt provisioning and CSR spends were higher in Q1 and should be a tailwind in the coming quarters.

Sequentially, revenues for the Communications (down 16.2% q-o-q, cc) and Consumer business unit (down 12.4%) fell the most; however, they have stabilised in Q2, according to management, along with revenues for the Technology vertical. However, nearly 70% of the remaining business continues to face uncertainty.

The moderation in utilisation levels, increase in variable payouts and investments in growth should limit significant margin expansion from the current levels. Any potential business restructuring by the new CEO could further be a risk to margins in near term. We already factor in a~30bps y-o-y increase in FY21 margins in a weak demand environment.

Retain Hold but raise TP to Rs 230

We increase our Ebit margin estimate for FY21e by 50bps, leading to a rise of c5% to our EPS estimate for FY21e. Wipro has lagged peers in growth for a while, and we await an upgrade to its growth profile before we would expect it to bridge the gap in valuation to peers.