Dark horse, this time?
Multiple factors in favor
* Wipro’s ability to control costs and collections justifies the improvement in EBIT margin/cash conversion, despite the sharp drop in revenue. While full impact of the COVID-19 pandemic on pricing and Working Capital (WC) cycle is yet to play out, Wipro’s outlook on managing margin stability (v/s Jun’20) and healthy cash conversions are impressive.
* In the current context, some of the verticals (Health BU) – earlier an overhang – should recover. Additionally, other factors in favor are playing out, such as (a) upside of a turnaround under a new CEO/strategy, and (b) possibility of large capital return.
* We upgrade our FY21/FY22E EPS by 6%-12%, largely led by margin surprise. Before turning constructively positive on the stock, we await a refresh of the company’s strategy and further evidence related to execution. Maintain Neutral.
Revenues in line; Margins – a surprise
* Wipro reported revenue (USD)/EBIT/PAT growth of -6%/7%/0.1% YoY.
* While revenue decline in Americas was largely in line with overall revenue decline (4.4% YoY, CC), Europe remained a drag (-7.7% YoY, CC).
* While other verticals were reasonably resilient, Communications (~17% YoY, CC) and BFSI (~7% YoY, CC) witnessed the biggest drop in revenue.
* Unlike TCS and Accenture, we do not believe Wipro’s Healthcare vertical (14% of revenue) has benefited much on account of COVID-19.
* EBIT margin of IT services segment was a surprise (19%, 300bp higher). Sequentially, margin expansion was driven by (a) operational efficiencies and cost control (+100bp), and (b) favorable currency (+100bp). Part of this was offset by the increase in provision for doubtful debts (-50bp impact).
* Sub-contracting rationalization led to ~200bp improvement in net utilization.
* FCF generation during the quarter remained healthy (158% of net income).
Focus on profitable growth; Confident outlook on margins
* Wipro’s new CEO has indicated that the company’s focus is on profitable growth.
* On YoY basis, order book is looking better. Deal pipeline is also stated to be healthy. As the company enters 2QFY21, deal activity is expected in Consumer, Technology and Communications while it remains cautious in other verticals.
* In BFSI, there is good demand around RTB and cost optimization spends.
* Thought visibility has improved slightly (v/s Mar’20), management has refrained from providing guidance.
* Near-term focus is on tightly controlling incremental spends. The company has hinted at maintaining IT services’ margins in a narrow band (v/s Jun’20).
Valuation and view – All set for multiple re-rating?
* Over the past few years, Wipro has underperformed Tier-I companies on growth, partly due to higher exposure to verticals facing challenges (e.g. Healthcare and ENU). Additionally, changes at the company level (e.g. restructuring in India/the Middle East, etc.) have further constrained growth. However, we expect scope of recovery in some verticals (e.g. Health BU).
* Despite the COVID-19 impact, margin resilience/cash generation was impressive this quarter. Management’s outlook of maintaining margins within a narrow band (v/s Jun’20) should result in strong EPS consensus upgrade.
* We believe Wipro is a good re-rating candidate due to the (a) upside of a turnaround under the new CEO, (b) possibility of an impending buy back, and (c) relatively attractive valuations (v/s TCS and Infosys, 13x 1-year forward P/E).
* Before turning constructive on the stock, we await a refresh of the company’s strategy and further evidence related to execution. Maintain Neutral.
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