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Consulting to remain soft; margin has bottomed

We interacted with the management of Wipro on demand environment and steps to improve profitability from its current levels. Key takeaways are as under:

Discretionary spend to remain muted; long-term demand intact

* Although clients continue to be highly cautious on their discretionary spends, WPRO is not seeing any cancellations so far. Pricing remains good and the deal pipeline is healthy.

* WPRO is seeing some slowdown in Capco, but the management believes that it should be the first to bounce back once the macro environment stabilizes in a few quarters.

* Capco leadership has seen multiple demand cycles, and hence, it does not expect the slower growth to have any significant impact on profitability.

* BFSI continues to be resilient; it is seeing some slowdown in Hi-Tech (impact from hardware providers) and Healthcare (normalization of Covid-led spends).

* Despite a weak macro environment, strong localized leadership team in Europe is helping WPRO gain market share in Europe.

* There is a lot of unused cloud capacity, so deceleration in hyperscalers should not immediately percolate and adversely impact the demand for IT services. With only 35-40% workloads moved to cloud, the management expects the tailwinds to continue for three to four years.

Expect higher furloughs in 3Q; attrition easing

* The management suggested higher-than-usual furloughs in 3QFY23. Apart from traditional furloughs from BFSI, it will see elevated furloughs in Tech. The furloughs are expected to be higher than pre-covid levels.

* During the peak, lateral joining ratio declined to 40%. With normalization in the job market, the ratio is improving.

* The worst of supply issues are now behind and the management is able to get the right talent at a right price.

* The management is already witnessing moderation in attrition. Attrition should further ease up in H2FY23.

Margins to improve; M&A unlikely

* There are some inefficiencies in terms of the pyramid structure and productivity as it is focused on capturing demand over the last year. The management is now prioritizing cost optimization.

* The anticipated tailwinds in 2Q are coming on expected lines and the margin should stabilize or improve from its current levels.

* The management suggested that 15% is the floor for the margin and with the help of cost optimization, the management will hold it despite a two-month impact from wage hike in 3QFY23.

* The margin for Capco is higher than previously anticipated and it is able to manage the utilization well.

* From a capital allocation view, it is looking for mid-sized deals, but M&As are unlikely due to two headwinds – 1) unclear macro environment and 2) promoters unwilling to sell at lower valuations.

* With the current levels of net cash available, the company is unlikely to do a Buyback in FY23. It will maintain the payout ratio at 45-50% of net income through the dividend route.

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