Wipro Q1 review: Margin woes remain

Wipro Ltd.’s close to 200-basis-point contraction in IT services margin in the first quarter was a “shocker” but improving utilisation, cost optimisation, and a decline in attrition rate may help margin to recover gradually, according to analysts. Also, an record deal pipeline offers hope, analysts said.

Revenue of the IT services exporter rose 3.21% sequentially to Rs 21,528.6 crore in the quarter ended June, in line with the Rs 21,489.4-crore consensus estimate of analysts.

Key highlights (QoQ)

• Net profit fell 17% to Rs 2,563.6 crore
• Ebitda fell 9.3% to Rs 3,085.6 crore
• Margin contracted 198 basis points to 14.3%.
• 12-month trailing attrition rate stood at 23.3%
• Revenue from IT services jumped 0.5% to $2,735.5 million. It grew 2.1% in constant currency.
• Wipro met its own revenue guidance of $2,748-2,803 million for the first quarter. It had maintained double-digit growth for the financial year ending March 2023.

“We have guided for 3-5% growth in revenue on a sequential basis. That translates into IT services business to be in the range of $2,817-2,872 million in second quarter,” said Thierry Delaporte, managing director and chief executive officer at Wipro.

Shares of Wipro fell as much as 2.3%, before reversing losses to end 0.4% higher.

Of the 45 analysts tracking the company, 16 maintain a ‘buy’, 14 suggest a ‘hold’ and 15 recommend a ‘sell’, according to Bloomberg data. The 12-month consensus price target implies an upside of 16.8%.

Here’s what analysts made of Wipro’s Q1 FY23 results:

Nomura

• Maintains ‘neutral’, cuts target price from Rs 490 to Rs 440, still implying a potential upside of 6.8%.
• Management guidance of 3-5% QoQ revenue growth for Q2 is reasonably good.
• Margin recovery to be gradual through FY23. Wipro management stated Q1 is likely the bottom for FY23 and margins should improve through the remaining quarters, aided by these key levers—improving utilisation, lower subcontracting expenses, selective price increases, continued pyramid optimisation, flattening attrition and operating leverage as growth picks up.
• Expects gradual recovery in EBIT margin over Q2-Q4 with 17% EBIT margin in Q4.
  Wipro had 18 large deal wins in Q1 FY23, most of which were new as per management. Deal pipeline is at an all-time high, owing to
• Wipro’s strong participation in deal market.
• Prefers Infosys.

Phillip Capital

• Downgrades from ‘buy’ to ‘neutral’, cuts target price from Rs 540 to Rs 410, implying no potential upside.
• Wipro reported modest Q1 performance, below expectations. The sharp fall in margin this quarter, with the big headwind of wage hike yet to come means the company will, most likely, end up well below its earlier guided range of 17.0-17.5% EBIT margin.
• Over the last seven quarters, Wipro’s margins have fallen by over 600 bps, primarily due to acquisitions like Capco and Rizing, which have led to a big reset at gross margin levels. These acquisitions have also consumed significant cash—leading to higher interest expense. All that has not led to any significant outperformance on the growth front—as Wipro appears likely to report, at best, industry average growth in FY23.
• While the stock has corrected sharply in last few months, there doesn’t appear to be any significant potential trigger, in near future.
• Inexpensive valuations and high dividend yield can, at best, limit the downside potential of the stock.
• Wipro’s stock will underperform its peers, as the company will continue to underperform its peers in growth/margin performance.
• Cuts FY23/24 estimates (-6%/-6%) on lower margins. Downgrades target multiple for Wipro to 16x FY24 PE (earlier 20x)—on lower earnings growth visibility and lack of potential triggers.
• The multiple is at 10% discount to Phillip Capital’s target multiple for HCL Technologies (18x) and in line with Tech Mahindra.

Nirmal Bang

• Maintains ‘sell’ at a target price of Rs 362, implying a potential downside of 12%.
• The weak Q1 is typical because of productivity benefits that it generally gives out to certain large clients. Revenue growth guidance for Q2 FY23 was given at 3-5% QoQ in CC terms against our expectation of 2-4% and probably reflective of the strong large deal TCV of $1.1 billion booked in Q1.
• The big EBIT margin decline of 200 bps QoQ in IT services to 15% was a shocker. This was 100-120 bps lower than our/consensus estimate. This is even before the compensation increase kicks in, with quarterly promotions being initiated starting July 1 and the annual salary hikes to be given from Sept. 1. The sense we get is that while 15% is probably the bottom for FY23, margin is unlikely to be very different in Q2; it will improve only gradually and will not hit the 17-17.5% medium-term target even once in any quarter of FY23.
• Suspects that this target may remain elusive even in FY24 despite multiple levers that are at Wipro’s disposal. The margin compression has meant that EPS for FY23 has had to be cut by 20% over the last six months. While Wipro had indicated before Q1 FY23 started that EBIT margin would fall short of the medium-term target of 17-17.5% for a few quarters because of investments, this kind of sharp dip in margin was not anticipated.
• Levers for margin improvement include: utilisation, Q1 was 500 bps from recent peak; sub-contractor cost optimisation; pyramid improvement—the largest—due to aggressive fresher addition; pricing; reduction in attrition and operating leverage.
• The strong revenue guidance for Q2 FY23 was given on the back of robust demand as no slowdown/pullback in spends has been reported.
• Overall pipeline is at an all-time high. The management commentary on strong near-term demand echoes that of its peers. But Nirmal Bang suspects the compression in IT spending will only happen when the current record profitability of customers sees a dent over the next 12-18 months because of slowing growth and inflation/supply chain pressures.
• The EBIT margin for FY23 will likely be 900/700 basis points lower than that of TCS/Infosys. Giving Wipro the benefit of the doubt on FY24 and leave EPS estimates largely intact.

Morgan Stanley

• Maintains ‘underweight’ stance with a target price of Rs 355, implying a potential downside of 12%.
• An all-around miss in Q1; Q2 guidance better than expected.
• Excluding the Rizing acquisition, which was not built into the guidance, MS estimates growth at 1.3% vs. the guided range of 1%-3%.
• Upside risks: Consistent deal win momentum under new CEO. Revenue growth surprising positively in FY23.
• Downside risks: Macro weakness (potential escalation of geopolitical tensions and inflation risks hampering global macro environment) or portfolio-specific client challenges, weak margins, integration issues in large-scale acquisition (Capco).

Motilal Oswal

• Maintains ‘neutral’, cuts target price to Rs 390, implying a potential downside of 5%.
  Strong deal booking, highest ever pipeline, and elevated hiring indicates good near-term revenue growth visibility, although it will continue to trail peers in organic growth in FY23.
• The drop in EBIT margin in Q1 surprised us, given the absence of any one-time factor. While Wipro should see a margin improvement in Q2 as it shifts the full impact of the wage hike to Q3. It is likely to stay meaningfully behind its 17-17.5% medium-term EBIT margin guidance for IT services over the next two years.
• With continued concerns on the macroeconomic environment, MO see Wipro’s consulting exposure (over 10% of revenue added in the last one year) as a potential risk to both growth and profitability. While it is not seeing any impact currently, MO expects the impact of a slowdown on client spend on the industry in the second half of FY23, which should have a more pronounced drag on its recent acquisitions (Capco and Rizing) in the consulting space. This remains the key concern on the stock price.
• We maintain ‘neutral’ as we await further evidence of the execution of Wipro’s refreshed strategy, and a successful turnaround from its growth struggles over the last decade before turning more constructive on the stock.

Kotak Institutional Equities

• Maintains ‘reduce’, cuts target price to Rs 410, implying no potential upside.
• Wipro reported an all-round weak quarter with significant miss on revenues, margins and earnings. The only positives were robust deal wins and strong headcount addition.
• Wipro is more vulnerable than peers in a slowdown courtesy of additional challenges of turning around a business and enhanced exposure to discretionary businesses due to recent acquisitions.
• EBIT margin has declined to a new low even before wage revision. Besides the general industry-wide pressure, Wipro’s headwinds also result from investments to turn around the operations. These include leadership refresh, induction of several new global account executives and competencies including acquisitions to name a few. Success in many of these initiatives is critical to improve margins. In the near term, the company has to contend with wage revision and other headwinds.
• Wipro has a lot more to manage than peers including executing a difficult turnaround and managing large acquisitions that have increased the risk profile of the business.

IDBI Capital

• Maintains ‘hold’, cuts target price to Rs 412, implying potential downside of 2%.
• Below estimates particularly on profitability side. Expects the company to witness healthy growth led by strong order book and robust guidance of 3-5% QoQ in Q2 FY23.
• However, considering the macro challenges & consulting business we expect revenue growth to taper.
• Further, Wipro sees headwinds in margins and hence expects margins to be below its guided range (17-17.5%) in next two-three quarters. It expects to maintain its margins at 17-17.5% post that.

Bloomberg