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Turnaround on track, but valuation leaves little room for a miss

Margin dip remains a key concern

* WPRO reported a strong, broad based sequential growth (12% CC) in 1QFY22. The organic sequential growth of 4.9% was the highest in the past nine years and was above the management’s guidance (2-4% QoQ CC) and our estimate. Capco contributed two months of revenue in 1QFY22 and witnessed a strong sequential growth. EBIT margin from IT Services dipped 340bp QoQ to 17.6% (excluding a one-time gain from sale of investments, 50bp above our estimate) on account of the Capco acquisition (130bp), partial wage hike for senior employees, and investments in talent.

* The company reported a TCV of USD715m in 1QFY22. There was a healthy mix of deals across verticals and geographies. This was not driven by any large deal, but was a healthy mix of medium and small deals, lending confidence on a broad based demand scenario.

* Growth guidance at 5-7% QoQ was in line with our estimate, which will include one month of Capco revenue and partial revenue from Ampion, which is expected to be close in 2QFY22. The robust growth guidance reflects a strong demand scenario and the company’s improving execution capabilities. With this, we expect revenue growth at 27% (18% YoY organic growth) from IT Services in FY22.

* WPRO should see multiple margin headwinds: 1) wage hikes, 2) Capco integration, 3) retention/hiring related expenses, and 4) investments. While cost synergies and continuous cost optimization should partially cushion this impact, it should result in a 340bp YoY reduction in EBIT margin in FY22E. This should in turn lead to a 7.6% PAT growth in FY22E, the weakest in our largecap coverage.

* We view the management’s growth strategy, continued investment in talent, and a simplified operational model to help improve the focus on customers as a step in the right direction.

* We upgrade our FY22E/FY23E EPS estimate by 6% to factor in a better growth performance. We maintain our Neutral stance as we view the current valuation as fair. Our TP implies 23x FY23E EPS.

Strong beat on operations

* In USD terms, revenue rose 25.7% YoY (est. 22.5%), EBIT from IT Services grew 23% (above our estimate), and PAT grew 35% (est. 8.4%) in 1QFY22.

* Revenue from IT Services increased by 12% QoQ CC to USD2,414.5m, above our estimate and on the higher side of WPRO’s guidance of 8-10%.

* Organic sequential growth is the highest in the past nine years. CAPCO contributed two months of revenue during the quarter. In 1QFY22, 4.9% QoQ was organic and the rest was from Capco.

* Growth in 1QFY22 was led by BFSI/Consumer/Communications/E&U (+22.4%/+14.1%/+12.8%/11.1% QoQ CC). Manufacturing fell 1.1% QoQ CC.

* Growth was broad based across the US and Europe. APMEA saw a 1.3% QoQ growth in 1QFY22. 

* WPRO closed eight large deals with over USD30m TCV. The TCV booked in these deals was over USD715m.

* The EBIT margin in IT Services dipped 220bp QoQ to 18.8% (170bp above our estimate) on account of the Capco acquisition (130bp), partial wage hike for senior employees, and investments in talent.

* PAT grew 35% YoY to INR32b, a 25% beat to our estimate, led by higher operating income and lower ETR (16% v/s our estimate of 22.5%). Lower ETR was due to certain tax benefits in 1QFY22.

* Net utilization rose 90bp QoQ, while attrition grew by 340bp. WPRO saw a net addition of 12.2k employees in 1QFY22.

* OCF stood at INR33.5b in 1QFY22, implying an OCF/PAT of 103.7%, while FCF stood at INR29b, implying a FCF/PAT of 89.6%.

* For 2QFY22, WPRO has guided at a QoQ CC revenue growth of 5-7%. This will include an impact from one month of the Capco acquisition.

Key highlights from the management commentary

* 1QFY22 witnessed broad based growth led by volumes and revenue from Capco, which was ahead of the management’s guidance. Billable headcount addition was also the strongest ever.

* Traditionally, summer time in Europe is soft and hence seasonality would come into Capco’s revenue. However, there will be a certain level of continuity in linearity and growth would be fueled by higher headcount.

* The management guided at 5-7% QoQ (CC) growth in 2QFY22. Even at the lower end of its guidance, WPRO will cross USD10b of revenue in FY22. Even after excluding Capco, it expects strong double-digit growth.

* WPRO may offer a second round of wage hikes in CY21 due to increased supply pressures. Two months of salary impact are expected in 2QFY22.

* The management intends to maintain margin in a narrow band (17-17.5%) in the foreseeable future.

Valuation and view – aptly priced

* In the past few years, WPRO has underperformed Tier I companies on growth due to its higher exposure to challenged verticals (such as Healthcare and ENU). Changes at the company level (restructuring in India/the Middle East) have further constrained growth. We expect the refreshed strategy of the new management to make the organization leaner. Its growth-focused approach would aid growth over the medium-to-long term. 

* The current restructuring and investments will take a toll on near term margin, eating away at the gains from operational efficiency. This should keep margin rangebound. 

* We increase our FY22E/FY23E EPS by 6%, largely based on better growth visibility. We maintain our Neutral stance as we await: a) further evidence of execution of WPRO’s refreshed strategy, and b) successful turnaround from its growth struggles over the last decade before turning more constructive on the stock. Our TP implies 23x FY23E EPS.

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