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Wipro: Enterprise business thrust...

Jan 24, 2005

Introduction to results
Wipro has reported decent results for the quarter and nine-month period ended December 2004. However, a marginal contraction in operating margins has led to net profits growth remaining muted in relation to the growth in the topline. Higher employee costs have been the major culprit behind the fall in operating margins in this quarter.

Financial performance (Consolidated): A snapshot
(Rs m) 2QFY05 3QFY05 Change 9mFY04 9mFY05 Change
Sales 19,885 21,038 5.8% 40,666 58,594 44.1%
Expenditure 14,566 15,684 7.7% 32,014 43,506 35.9%
Operating profit (EBDIT) 5,319 5,354 0.7% 8,652 15,088 74.4%
Operating profit margin (%) 26.7% 25.4% 21.3% 25.8%
Other income 76 271 257.5% 840 631 -24.8%
Interest 15 23 52.5% 28 50 77.6%
Depreciation 570 656 15.0% 1,395 1,741 24.8%
Profit before tax 4,809 4,946 2.8% 8,069 13,929 72.6%
Tax 702 722 2.8% 922 2,035 120.7%
Minority interest (22) (27) (35) (72)
Equity in earnings of affiliates 33 71 (5) 133
Profit after tax/(loss) 4,117 4,268 3.7% 7,107 11,955 68.2%
Net profit margin (%) 20.7% 20.3% 17.5% 20.4%
No. of shares 699.0 699.0 232.8 699.0
Diluted earnings per share* (Rs) 23.6 24.4 13.6 22.8
P/E ratio (x) 29.2
(* annualised)

About the company
Wipro is the third largest software services exporter from the country and also has interests in the consumer care and lighting businesses. However, the largest contribution to its revenues comes from the global IT services and products division (75% of consolidated revenues). Within the global IT services business, the company derives revenues from application development and maintenance (37% contribution), R&D services (32%), package implementation (11%) and systems integration and consulting (4%). The company also provides BPO services through its subsidiary, Spectramind (11% of global IT services revenue).

What has driven performance?
Global IT services aids topline: Wipro's Global IT services segment (75% of consolidated revenues) continues to guide the topline growth for the company. In 3QFY05, revenues from the segment have grown sequentially by 6%, aided mainly by continued strength in volumes and 1% improvement in both onsite and offshore billing rates. Revenues of the ITES business (Wipro Spectramind) now form 11% of the Global IT services revenues and have grown sequentially by 6% in 3QFY05. Revenues from R&D services (32% of Global IT services) have grown sequentially by 3% while those from the Enterprise business have grown by 8% QoQ. In the past few quarters, Wipro has witnessed increased traction in the R&D business that was otherwise a 'weak-link' of the company during the years of slowdown in global technology spending. This is a positive as the high technology intensive nature of Wipro's business provides it with an edge over its peers like Infosys and TCS who have a relatively larger proportion of revenues coming from the enterprise segment.

The company added 26 (34 in 2QFY05) clients in the quarter, including 16 (10) in R&D services and 10 (21) in enterprise business. Wipro's addition to the employee base was in line with what has been witnessed for Infosys and TCS. The company hired a net of 2,300 employees in the quarter, with almost 42% (947) being added in the ITES segment. These aggressive level of hiring from the top players seem to be in anticipation of increased outsourcing business likely to come India's way. We believe that Wipro, due to its large size and breadth of offerings, is likely to be a key beneficiary of the same. At the end of 3QFY05, the company had an employee base of 39,337, including 14,340 in ITES.

Higher employee costs dent margins: A 320 basis points expansion in employee costs (as % of revenues) has been a major reason for the decline in Wipro's operating margins in 3QFY05. On a PBIT basis, margins for the Global IT services business have declined by 150 basis points.

Pared net profit growth despite high other income: The net profit growth in 3QFY05 has been muted in relation to the growth in topline despite a four-fold rise in other income. This sedate growth in net profit has been mainly a result of the contraction in operating margins and higher interest charges. The strong growth in other income has been mainly on account of forex gains of Rs 41 m in 3QFY05 (from losses of Rs 117 m in 2QFY05). At the end of 3QFY05, Wipro has hedged receivables of around US$ 614 m. Moreover, Wipro's onsite component constitutes around 30% of Wipro's employee costs and, to that extent, the company has a natural hedge against volatile currency movements.

What to expect?
At the current price of Rs 666, the stock is trading at a price to earnings multiple of 29.2 times annualised 9mFY05 earnings. This is at the higher end of the valuation spectrum. Wipro's management expects revenues from the global IT services division to grow sequentially by 5% in 4QFY05 to US$ 370 m. These expectations seem to be based on the belief that the strong volume growth momentum continues and pricing environment remains stable. Like Infosys, Wipro has also crossed the US$ 1 bn revenue mark in the nine-month period and is poised to marginally outperform our revenue and profit projections for FY05. However, much of the medium term growth of the company seems to have been already factored into the current stock price and, as such, investors need to practice caution at these levels.

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