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Wipro: Margin pressure continues
Jan 18, 2008

Performance summary
  • Topline grows by 12.2% QoQ during 3QFY08, driven by 6.4% QoQ growth in volumes and 0.5% QoQ improvement in billing rates.

  • Operating margins contract by 0.7% QoQ mainly due to low margins of Infocrossing, which was acquired during the previous quarter.

  • Bottomline expands by 4% QoQ - impacted by higher interest expenses and decline in operating margins.

  • Adds 39 clients and 2,400 employees during 3QFY08. US markets grows at 7% QoQ.

Consolidated financial snapshot
(Rs m) 2QFY08 3QFY08 Change 9mFY07 9mFY08 Change
Sales 47,574 52,706 10.8% 106,759 142,640 33.6%
Expenditure 38,075 42,533 11.7% 82,050 114,743 39.8%
Operating profit (EBDIT) 9,499 10,173 7.1% 24,709 27,897 12.9%
Operating profit margin (%) 20.0% 19.3% 23.1% 19.6%
Other income 1,262 1,626 28.8% 1,996 4,131 107.0%
Interest 330 760 130.3% 84 1,221 1346.7%
Depreciation 1,245 1,428 14.7% 2,888 3,849 33.3%
Profit before tax 9,186 9,611 4.6% 23,732 26,958 13.6%
Tax 1,046 1,100 5.2% 3,122 3,151 0.9%
Minority interest (1) 11 (4) 7
Share of earnings in associates 96 40 -58.3% 246 233 -5.3%
Profit after tax/(loss) 8,237 8,540 3.7% 20,860 24,033 15.2%
Net profit margin (%) 17.3% 16.2% 19.5% 16.8%
No. of shares (m) 1,446 1,458
Diluted earnings per share (Rs)* 22.4
P/E ratio (x)* 20.6
* On a trailing 12-months basis

What has driven performance in 3QFY08?
  • Wipro recorded 11% QoQ growth in its topline during 3QFY08. This was driven by 6.4% QoQ growth in volumes and 0.5% QoQ improvement in billing rates. The Global IT service (68% of total revenues) segment recorded 11% QoQ growth while Wipro Infotech (India, Middle East and Asia Pacific software services) recorded 4% QoQ growth. The consumer care and lighting division of Wipro recorded 17% QoQ growth during the quarter. Wipro, over the last 24 months, has made a string of acquisitions, which got reflected in topline growth during the third quarter as well. Revenues from acquisitions recorded a 856% QoQ growth (mainly due to small base) and the contribution of acquisitions to the Global IT revenues has risen from 1% in 2QFY08 to 7% in 3QFY08.

    Segment wise breakup
    Rs m 2QFY08 % of total 3QFY08 % of total % change
    Global IT services 32,490 67.5% 36,163 67.8% 11.3%
    IT Services 29,452 30,683 4.2%
    Acquisitions 254 2,429
    BPO Services 2,784 3,051 9.6%
    India & AsiaPac 9,312 19.4% 9,716 18.2% 4.3%
    CC&L 3,726 7.7% 4,347 8.1% 16.7%
    Others 2,587 5.4% 3,122 5.9% 20.7%

  • Wipro’s operating margins have come down by 0.7% QoQ during 3QFY08, mainly because of acquisitions that have relatively low margins than the core organic business. While on an organic basis, the margins of global IT segment have remained flat despite a wage hike Infocrossing’s acquisition dented the operating margins to the extent of 1.1% in 3QFY08. The acquisitions, which contributed to 7% of the total topline during 3QFY08, contributed to only 2% of the PBIT. Of the total capital employed by Wipro, 18% has gone into acquisitions, which have operating margins of just 5% when compared to 23% (34% capital employed) in Global IT services and 22% (only 2% capital employed) in BPO.

    Revenue break-up by service offerings
      2QFY08 3QFY08  
      Rs m % of total Rs m % of total Change
    Technology Infrastructure Services 5,423 11.4% 5,850 11.1% 7.9%
    Testing Services 5,566 11.7% 6,272 11.9% 12.7%
    Package Implementation 5,614 11.8% 6,219 11.8% 10.8%
    Consulting 618 1.3% 738 1.4% 19.3%
    BPO 4,234 8.9% 4,744 9.0% 12.0%
    ADM 26,118 54.9% 28,883 54.8% 10.6%
    Total revenues 47,574 100.0% 52,706 100.0% 10.8%

  • Wipro’s bottomline expanded by just 4% QoQ mainly due to lower operating profits and higher interest costs. Operating profits, which expanded by just 7% QoQ had their impact on the slow bottomline growth, while interest costs, which have risen by 130%, QoQ also negatively impacted the same.

    Revenue by Industry vertical
    2QFY08 3QFY08
    Rs m % of total Rs m % of total Change
    Product Engineering Services 11,751 24.7% 13,071 24.8% 11.2%
    Telecom Service Provider (TSP) 3,806 8.0% 4,216 8.0% 10.8%
    Technology business (A) 15,557 32.7% 17,288 32.8% 22%
    Financial services (B1) 11,513 24.2% 13,018 24.7% 13%
    Retail 4,520 9.5% 5,112 9.7% 13.1%
    Energy and Utilities 4,472 9.4% 4,796 9.1% 7.3%
    Utilities 4,520 9.5% 4,954 9.4% 9.6%
    TMTS 5,661 11.9% 6,061 11.5% 7.1%
    HLS 1,332 2.8% 1,476 2.8% 10.8%
    Enterprise Solutions (B2) 20,504 43.1% 22,400 42.5% 9%
    Enterprise Business (B1+B2) 32,017 67.3% 35,418 67.2% 11%
    Total revenues (A+B) 47,574 100.0% 52,706 100.0% 10.8%

What to expect?
At the current price of 460, the stock is trading at a multiple of 11.7 times our estimated FY10 earnings. While we remain positive on the stock from a long-term perspective as it is trading at attractive valuations, we are cautious of the trend in margins going forward. Firstly, the margins could decline as the acquisitions are in the low margins segment and secondly, the topline growth (34% YoY in 9-months) might not translate into a corresponding bottomline growth (only 15% YoY during 9mFY08) resulting into lower returns on capital employed going forward.

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