A tale of two companies

SMARTSHARE

Two market leaders in different tech sectors came through with their Q2 2005-06 results last Wednesday. It would not have made a difference in a falling market, but neither Wipro nor Biocon delivered numbers of the sort that inspire bullish sentiment.

There is little basis for comparing the two companies at first or even third glance; they are in completely different businesses. However, both benefit from the falling rupee and both exploit inherent labour arbitrages.

The lacklustre results are due to a combination of rising costs and pricing pressure. Both companies do expect far better results going forward, but this is partially priced into current valuations.

Wipro has delivered nice quarter-on-quarter numbers with the IT division's revenue numbers rising 8 per cent and Q-Q operating profits up by 10 per cent. In year-on-year terms, the results are less enticing.

Wipro has 25 per cent growth in revenues in H1, 2005-06 compared to H1, 2004-05 but it has managed only a 16.8 per cent rise in OP. Compare that to Infy and TCS which delivered 30 per cent and 26 per cent OP growth respectively. If we exclude income from treasury operations, Wipro's OP growth was just about 13 per cent. Operating margins have dropped across the board. Margins are down drastically in the BPO business (down 10 per cent). Even in the IT services business, margins dipped 2.3 per cent.

Analysts expect a consensus EPS growth of 25 per cent across 2005-06. That translates to somewhere between Rs 14-15 earnings per share. In order to meet these targets, Wipro must deliver standout H2 performance.

It's a tough call to make with a blue-chip of this quality but common sense suggests there is a large downside for the stock and very little upside. Valuations are rich, as they have always been.

The stock trades at 28 times its 2004-05 earnings and 25 times its expected 2005-06 EPS. If it meets consensus EPS targets, Wipro will maintain a PEG of 1, which is tolerable. If it fails to meet the 2005-06 target, there may be a big sell-off.

Biocon is a more difficult business to value, not least because overall understanding of the biotechnology business is less. I am not even going to try to second-guess estimates! PBT in Q2, 2005-06 fell 13 per cent though revenues rose 8 per cent. Core expenses rose 3.5 per cent and OPM dropped by a similar amount. PAT dropped by 21 per cent versus Q2, 2004-05.

Biocon cited pricing pressure in Europe and said that expansions into contract research and into new lines in diabetics and oncology products would pay off soon. On a Q-Q basis, OP rose 15 per cent, which does suggest that refocus is working. OPM has been steady through April-September at about 30 per cent. The company says it has managed to register its insulin drug across some 30 nations thereby opening up new markets.

Is there a possibility of a sell-off here? The problem is that biotech and biopharma are black boxes for most people, including financial analysts. If Biocon meets targets, it's priced okay. There could be an upside since two (or three) lacklustre quarters may be followed by a big jump in operating numbers. Otherwise, there could be a deluge.