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Wipro: Growth momentum continues - Views on News from Equitymaster
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Wipro: Growth momentum continues
Jan 17, 2007

Performance summary
Wipro has announced strong results for the third quarter and nine-months ended December 2006. For 3QFY07, revenues and net profits have grown by 12% QoQ and 9% QoQ respectively. Noticeably, the company has outperformed both its peers, Infosys and TCS, in terms of the sequential revenue growth this quarter. However, unlike the other two, who have reported expansion in operating margins, Wipro’s margins have taken a 110 basis points (1.1%) hit during 3QFY07, mainly due to pressure on profitability of the organic Global IT services business, which has seen its margins decline by 0.5% sequentially. For the nine-month period as well, while topline and bottomline have grown at stellar rates, operating margins have been negatively impacted.

Financial performance (Consolidated): A snapshot
(Rs m) 2QFY07 3QFY07 Change 9mFY06 9mFY07 Change
Net Sales 35,576 39,726 11.7% 75,310 106,759 41.8%
Expenditure 27,293 30,900 13.2% 57,073 82,050 43.8%
Operating profit (EBDIT) 8,283 8,827 6.6% 18,237 24,708 35.5%
Operating profit margin (%) 23.3% 22.2%   24.2% 23.1%  
Other income 694 825 18.9% 714 1,996 179.7%
Interest 34 48 44.1% 28 84 202.8%
Depreciation 983 1,011 2.8% 2,252 2,888 28.3%
Profit before tax 7,960 8,593 7.9% 16,671 23,732 42.4%
Tax 1,050 1,031 -1.8% 2,408 3,122 29.7%
Minority interest - (4)   1 (4)  
Equity in earnings of affiliates 92 89 -3.3% 233 246 5.7%
Profit after tax/(loss) 7,002 7,654 9.3% 14,495 20,860 43.9%
Net profit margin (%) 19.7% 19.3%   19.2% 19.5%  
No. of shares (m)       1,424.2 1,445.5  
Diluted earnings per share (Rs)*         18.7  
P/E ratio (x)*         34.2  
* On a trailing 12-month basis            

About the company
Wipro is India’s third largest software services exporter and also has interests in the hardware and consumer care and lighting businesses. However, the largest contribution to its revenues comes from the global IT services and products division (77% of consolidated revenues). Within the global IT services and products business, the company derives revenues from R&D services (32% of global IT services revenues), enterprise business (60%) and BPO services (8%). The company provides BPO services through its subsidiary, Wipro BPO Services. Over the period FY01 to FY06, Wipro’s consolidated revenues and profits grew at compounded rates of 28% and 25% respectively.

What has driven performance in 3QFY07?
Growth all across: Sustenance in strong sequential growth in IT services has led Wipro’s consolidated topline growth during 3QFY07. The company’s Global IT services business, which contributed to 72% of total revenues during the quarter (77% in 2QFY07), reported sales growth of 6% QoQ during the quarter. This was made up of 6% QoQ, 5% QoQ and 3% QoQ growth in the business’ organic, inorganic (acquisitions) and BPO sub-segments respectively. The mix of onsite to offshore revenues stayed put at 54.9% and 45.1% respectively during 3QFY07. As for services lines, while energy and utilities vertical stole the show with a 24% QoQ growth, it was followed by the retail segment, which clocked sales growth of 10% QoQ during 3QFY07. However, the bigger verticals of product engineering and financial services grew at marginal rates of 1% QoQ and 4% QoQ respectively.

Segmental break-up: All-round growth!
  2QFY07 3QFY07 Change
  Rs m Rs m %
Global IT services 27,205 28,755 5.7%
IT Services 23,538 24,962 6.0%
Acquisitions 1,368 1,435 4.9%
BPO Services 2,299 2,358 2.6%
India & AsiaPac 5,426 7,008 29.2%
CC&L 2,025 2,114 4.4%
Others 1,098 2,190 99.5%
Eliminations (292) (277) -5.1%
Total 35,462 39,790 12.2%

As for the other business segments of Wipro Infotech (India & Asia-Pacific IT services) and consumer care & lighting (CC&L), while the former grew at 29% QoQ, the latter recorded a 4% QoQ growth. The strong growth in Wipro Infotech was duly aided by the company’s acquisition of the Indian & Middle East operations of 3D Networks and Planet PSG, which earned revenues of Rs 477 m during the quarter.

On the clientele front, while Wipro added a gross of 37 clients during 3QFY07, the net figure was a negative 1, as the company’s client base stood at 592 at the end of the quarter (593 at the end of 2QFY07). However, in the past 12 months (since December 2005), the company’s net addition to the base stood at 107, with some part due to the number of acquisitions that the company did during this period. On the manpower front, Wipro added a net of 4,997 people during 3QFY07 (3,489 in IT services and 1,508 in BPO). Importantly, the strong addition to the BPO employee base comes after 584 employees reduction that the company had affected in 2QFY07. Attrition in the IT services business reduced to 16% in 3QFY07 (18% in 2QFY07), though still remaining much higher than that recorded by TCS (10.8%) and Infosys (13.5%).

Cost of services dent margins: While Wipro’s employee costs (as percentage of sales) witnessed a decline from 42.7% in 2QFY07 to 41.6% this quarter, the overall cost of sales and services saw an increase, thus denting the company’s operating margins by 110 basis points sequentially. The decline in employee costs was on account of a higher base effect, as the company had given a 12% to 13% salary hike to a part of its employees in September 2006. The management had already indicated that the impact of this on margins was a negative 150 basis points (1.5%), which was duly seen in 3QFY07. However, the management had also indicated that the company was to affect a similar hike in November 2006 for employees who were not covered by the hike in September. This, however, failed to show in the employee costs. Among other major cost heads, while selling and marketing (S&M) expenses saw some decline (5.7% of sales in 3QFY07 against 6.2% in 2QFY07), general and administrative (G&A) expenses increased to 5.2% of revenues (5% in 2QFY07).

As regards operating margins for specific businesses, it was the organic Global IT services’ performance, which impacted the company’s consolidated profitability during 3QFY07. This business reported a 0.5% operating margin contraction to 25.4% (25.9% in 2QFY07). The company’s acquisitions reported strong margin expansion, with their consolidated (all acquired entities) PBIT margins improving to 4.4% in 3QFY07, from 1% in 2QFY07. Wipro Infotech saw a marginal 20 basis points margin contraction in PBIT margins.

Margin contraction leads to bottomline underperformance: Due mainly to the contraction in Wipro’s operating margins during the quarter, its bottomline growth of 9% QoQ underperformed the growth recorded by the topline. But for a lower effective tax rate, the impact on the bottomline would have been larger.

What to expect?
At the current price of Rs 640, the stock is trading at a price to earnings multiple of 19.7 times our estimated FY09 earnings. Wipro’s management expects consolidated revenues from the global IT services and BPO divisions to grow sequentially by around 7% in 4QFY07 to US$ 685 m. The demand environment is buoyant, and this is clearly reflected in the guidance for the next quarter. As indicated by the management, there are a number of large deals globally that are coming up for renewals. We expect larger and scalable players like Wipro benefiting tremendously from the same. The fact that the company's inorganic growth initiatives are starting to show some positive results is an enthusing sign. Overall, while we expect volume growth to remain strong in the coming quarters, billing rates are likely to be more or less stable. We maintain our positive view on the stock from a long-term perspective.

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