Wipro: Strong operating margin, cash position offer comfort to investors

Going ahead, a good order book, a strong deal pipeline and the company's continued focus on cost optimisation are expected to help

Following the positive June 2020 quarter (Q1) results, announced on Tuesday after market hours, shares of Wipro surged by 15.5 per cent on Wednesday, outperforming the Sensex, which ended flat. The sharp uptick in Wipro’s stock, which was the top gainer in the Nifty IT index, also rubbed off on other IT companies, with the sectoral index jumping 5 per cent.

While Wipro’s strong margin performance and robust free cash flow — giving hints of higher returns to shareholders — were key positives from the Q1 results, the new managing director and chief executive officer’s (MD & CEO’s) confidence in delivering profitable growth revived Street sentiment.

Thierry Delaporte, who took charge as MD & CEO on July 6, indicated a strong focus on driving growth without hurting profitability. This was a shot in the arm for investors, given Wipro’s subdued operating performance in the past and consequently, its stock’s underperformance. Analysts are now hopeful of Wipro seeing a turnaround under the new CEO, who was associated with Capgemini in his previous stint.

“We believe Wipro is a good re-rating candidate because of the upside of a turnaround under the new CEO, the possibility of an impending buyback, and relatively attractive valuations (14.5 times FY21 estimated earnings versus over 20 times for TCS and Infosys),” analysts at Motilal Oswal Securities said in their report.

In Q1, while Wipro’s revenue grew 1.6 per cent year-on-year (YoY) to Rs 14,922.8 crore,  a tad below the consensus estimate of Rs 14,944 crore, its pre-tax profit of Rs 3,095.3 crore was around 15 per cent higher than analysts’ expectation of Rs 2,694.3 crore. The beat was led mainly by the strong IT services operating margin, which expanded by 140 basis points (bps) sequentially and 60 bps YoY to 19 per cent. Analysts were expecting operating margin to contract by up to 140 basis points. While currency gains helped, a large part of the margin improvement was on account of cost control. In constant currency terms, IT services’ revenue was down 7.5 per cent sequentially.

 

 

Better order book, strong deal pipeline and the company’s continued focus on cost optimisation should help the company fare better. The management also highlighted that the consumer, technology and communications verticals (about 35 per cent of FY20 revenues) will be more stable, compared to other verticals in the coming quarters.

The caveat, however, is weaker visibility on other verticals, including banking, financial services and insurance (BFSI), which accounts for over 30 per cent of Wipro’s revenue. The same holds true for most other domestic IT companies. This is a reason for analysts being sceptical of the strong deal and margin momentum continuing and thus, refraining from upgrading the stock.

The Bloomberg data shows only three of 29 analysts polled after Q1 results have upgraded the stock. Of the remaining, four have a "buy", 20 have a "neutral/hold" and two have a "sell" rating on the stock.

Sanjeev Hota, head of research at Sharekhan, says: “Though there are positives in Wipro’s Q1, we believe receding of headwinds in certain pockets like BFSI, the sustainability of margin performance, and building up of large deal engines will be key parameters before we upgrade the stock.” Sharekhan currently has a "hold" rating on the stock.

Analysts at Motilal Oswal Securities have also maintained their "neutral" rating, saying “before turning constructive on the stock, we await a refresh of the company’s strategy and further evidence related to execution".

Therefore, how the new CEO strategises broad-based growth for Wipro will be crucial. The Street will also see if the margin and deal trends sustain in the September quarter, and will be watchful of the management commentary, all of which should be deciding factors for the stock’s re-rating.