Wipro: Stretched valuations

Wipro's premium valuation is not justifiable

Wipro, like Infosys and Tata Consultancy Services (TCS), reported a double-digit sequential revenue growth in its global IT services and products business, but much of this growth came from the business process outsourcing (BPO) business.

Volumes in IT services business grew just 7.3 per cent, much lower than Infosys' 12.9 per cent volume growth. TCS didn't disclose volume growth, but much of its 13.9 per cent revenue growth was volume driven.

Worse still, Wipro's top 10 clients (IT services) saw a sequential decline of 1 per cent in revenues, with the top clients recording an 8.4 per cent drop in revenues. Clients outside the top 10, which grew 12.4 per cent sequentially, were responsible for the revenue growth of 7.8 per cent in IT services business.

Furthermore, despite better average realisations, a shift to offshore, and the benefit of a 2.5 per cent depreciation in average rupee rates, gross margin fell over 100 basis points. Wipro's operating profit growth of 8.2 per cent was much lower than Infosys' 14.7 per cent growth and TCS' 13.2 per cent growth.

Besides, the company's outstanding forward cover of $860 million (Infosys and TCS manage with a much lower cover of around $180 and $250 million respectively) when marked to market is in a loss position of Rs 188 crore, which hasn't been booked in the profit and loss yet.

This will be done over the next few quarters when the contracts expire. Coupled with the recent 15-18 per cent salary hike for offshore employees, this is expected to hit margins going forward.

Attrition rate at around 18 per cent (IT services), much higher than peers in top rung, continues to be a worry. In order to tackle this, Wipro has issued 5.5 million employee stock options to senior and middle-level management at a nominal price.

This is expected to result in a non-cash charge of Rs 340 crore which will be amortised over five years. This will result a charge of around Rs 17 crore (1.1 per cent of Q2 sales) for the next 20 quarters.

Margins will certainly be under pressure, and growth in reported profit should be lower than peers. Despite this, Wipro enjoys a valuation of 30 times estimated FY05 earnings, much higher than both Infy and TCS.

The reasons given for Wipro's premium include its wider service offering - especially the critical mass that it's achieved in each of its offering (except consulting, of course, which accounts for only around 2 per cent of revenues).

Some analysts point out that Wipro is better placed to see an improvement in pricing vis-a-vis peers. For some reason, the a bove factors have not resulted in superior growth or margins for Wipro in the past. The premium valuation, therefore, is hardly justifiable.

Inflation: A 60 basis point base effect

So this is what the much-awaited September base effect on the inflation data boils down to: a reduction in the inflation rate from 7.81 per cent in the week ended September 4 to 7.20 per cent for the week to October 2.

Apart from the base effect, what has changed? The wholesale price index hardly moved, and was 189.0 as on October 2 compared to 189.1 a month ago.

The irony is that this has been achieved by the near-heroic effort of lowering the fuel index at a time when international crude oil prices have gone through the roof. The index for fuel, power and lubricants fell from 281.6 as on September 4 to 281 on October 2. Clearly, this is unsustainable.

There isn't going to be any base effect in October, because the WPI at the end of October 2003 was more or less at the same level as at the end of September 2003.

Nevertheless, there are some grounds for hope""""the index for primary articles has been declining steadily in September this year, with the result that this index as on October 2 was 1.4 per cent lower than a month earlier, thanks largely to non-food primary products, which fell 2.8 per cent over the month. If this trend continues, it could offset to some extent the inevitable rise in fuel prices.

The better-than-expected inflation data had little effect on bonds on Friday, because of the fear of fuel price increases. What's interesting is that, while inflation has moved downwards by around 60 basis points over the past one month, the 10-year yield has moved up by about 80 bps.

With contributions from Mobis Philipose