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Wipro FY06 results: Our view - Views on News from Equitymaster
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Wipro FY06 results: Our view
Apr 19, 2006

Introduction to results
Wipro has announced strong consolidated results for the fourth quarter and full-year ended March 2006. For FY06, the company has reported impressive growth in topline, driven mainly by impressive volume growth in the key global IT services business, particularly offshore, apart from strong growth seen in key service lines, such as testing and technology infrastructure services. Margins, however, witnessed a decline, due mainly to higher employee costs. Due to considerably higher other income and lower minority interest, the bottomline grew at a faster rate than the operating profits. For the quarter, the story has been similar as well, with a double-digit sequential growth in both sales as well as profits being seen amidst lower margins.

Financial performance (Consolidated): A snapshot
(Rs m) 3QFY06 4QFY06 Change FY05 FY06 Change
Sales 27,652 30,719 11.1% 81,606 106,029 29.9%
Expenditure 20,747 23,582 13.7% 61,090 80,655 32.0%
Operating profit (EBDIT) 6,905 7,137 3.4% 20,515 25,374 23.7%
Operating profit margin (%) 25.0% 23.2%   25.1% 23.9%  
Other income 176 822 365.7% 945 1,536 62.5%
Interest 19 7 -62.6% 56 35 -37.7%
Depreciation 773 845 9.2% 2,456 3,096 26.1%
Profit before tax 6,289 7,107 13.0% 18,948 23,778 25.5%
Tax 948 983 3.7% 2,750 3,391 23.3%
Minority interest - -   88 1  
Equity in earnings of affiliates 94 55   175 288  
Profit after tax/(loss) 5,435 6,179 13.7% 16,285 20,674 26.9%
Net profit margin (%) 19.7% 20.1%   20.0% 19.5%  
No. of shares (m) 1,430.3 1,439.2   1,404.3 1,427.9  
Diluted earnings per share (Rs)       11.4 14.5  
P/E ratio (x)         39.2  

About the company
Wipro is India’s third largest software services exporter and also has interests in the hardware and consumer care and lighting (CC&L) businesses. However, the largest contribution to its revenues comes from the global IT services and products division (76% of consolidated revenues). Within the global IT services and products business, the company derives revenues from R&D services (37% of global IT services revenues), enterprise business (54%) and BPO services (9%). The company provides BPO services through its subsidiary, Wipro BPO Services. Over the period FY01 to FY06, Wipro’s consolidated revenues and profits have growth at compounded rates of 28% and 25% respectively.

What has driven performance in FY06?
Global IT services power the topline: During FY06, Wipro’s key business, global IT services and products, saw an impressive growth of nearly 33% YoY. Of this, IT services grew at nearly 34% YoY, while BPO grew at a more sedate 17% YoY. This year, Wipro has added one more segment for reporting purposes, that of acquisitions. As can be recalled, Wipro had acquired a few companies, such as NewLogic, mPower and cMango in FY06, with a view to gaining expertise in specific areas/geographies where they were not present. Revenues from these acquisitions totalled Rs 502 m in FY06 (NIL in FY05).

As regards global IT services, strong volume growth was the key driver in FY06. The year saw a strong offshore shift, with offshore revenues contributing to 46.3% of IT services revenues (44.0% in FY05). Offshore volumes grew at a rate of nearly 43% YoY, while onsite volumes grew at over 31% YoY. Billing rates were lower by 0.9% for onsite volumes, while they saw a marginal up-tick of 0.1% for offshore volumes. The major drivers in terms of service lines this year were technology infrastructure services and testing, which grew at rates of 56% YoY and 81% YoY respectively. However, BPO grew at a little under 17% YoY, due to restructuring carried out in this business.

Wipro added 42 new clients during the quarter. The total number of active clients now stands at 494 in IT services and 33 in BPO. The company added a net of 1,029 people in IT services in 4QFY06, taking the total number of employees to 37,655 in this business. On the BPO side, the company added a net of 1,689 people, taking the total headcount to 16,087. Thus, the total headcount in the company’s IT and BPO business now stands at 53,742. It should be noted that the attrition rate was at 16% during the quarter, part of which was extraordinary, in the sense that a number of employees who had submitted fake résumés to the company were asked to leave. This impacted attrition to the tune of 1.5%. For FY06, the attrition rate stood at 15% in IT services, the same level as in FY05.

Segmental break-up: Global IT services rule!
  FY05 FY06 Change % of revenue
  Rs m Rs m % %
Global IT services 60,753 80,660 32.8% 75.9%
IT Services 54,230 72,531 33.7% 68.3%
Acquisitions - 502 - 0.5%
BPO Services 6,523 7,627 16.9% 7.2%
India & AsiaPac 13,964 17,048 22.1% 16.0%
CC&L 4,723 6,008 27.2% 5.7%
Others 2,604 3,323 27.6% 3.1%
Eliminations (346) (781)    
Total 81,698 106,258 30.1%  

The other segments of Wipro also showed decent year-on-year growth. Wipro Infotech won 5 ‘total outsourcing’ contracts, including a Rs 3.6 bn 10-year deal from HDFC Bank. Thus, the year has been characterised by strong all-round growth in all the company’s major businesses.

Employee costs pressurise margins: In FY06, Wipro’s operating margins fell by 120 basis points. The chief contributor to this increase has been the increase in employee costs. As a percentage of sales, employee costs increased from 63.5% to 64.7%. Selling and marketing (S&M) expenses, however, reduced to 6.5% of sales in FY06 from 6.8% last year.

As regards PBIT margins for all the businesses, global IT services’ PBIT margins fell by 180 basis points (1.8%) to 24.6%. Wipro Infotech saw a 110 basis points margin expansion. Going forward, the management expects margins for this business to increase, as the proportion of services increases. For FY07, the management has said that it expects margins to move within a narrow range.

Other income, lower taxes drive the bottomline: Despite lower margins, the considerably higher other income (up by 63% YoY) and a lower effective tax rate for the year led to the bottomline growth outperforming the growth in operating profits. The effective tax rate, however, was low due to a Rs 100 m write-back in the fourth quarter. Excluding this, the net profit grew at 26% YoY. Profits earned on account of exchange fluctuations, as compared to a loss last year, as well as considerably higher interest on debt instruments and dividend on mutual fund units resulted in the higher other income this year.

Similar was the case for the quarter, with other income growing by as much as 366% QoQ, and a lower effective tax rate ensuring a strong double-digit QoQ growth of nearly 14% in net profits.

Performance in the recent past…
  1QFY06 2QFY06 3QFY06 4QFY06
Sales growth (%, QoQ) (1.3) 9.8 10.9 11.1
Profits growth (%, QoQ) (1.2) 11.7 13.7 13.7

What to expect?
At the current price of Rs 568, the stock is trading at a price to earnings multiple of 21.2 times our estimated FY08 earnings. The board has recommended a final dividend of Rs 5 per share (dividend yield of 0.9%). During the quarter under review, the company exceeded its guidance for the global IT services business, growing to US$ 512.3 m (including BPO) as compared to the guidance of US$ 510 m. Wipro’s management expects consolidated revenues from the global IT services and BPO divisions to grow sequentially by 4.0% in 1QFY07 to US$ 533 m. Given the fact that the first quarter of the financial year is traditionally a relatively slow quarter for Wipro, this is not necessarily a cause for concern.

The company has posted total revenues of Rs 80,660 m in its global IT services business, marginally lower by 1.3% compared to our estimates. The EBITDA margins, at 23.7%, under-performed our estimates of 25.0%, while the bottomline of Rs 20,674 m is lower by 1.0% compared to our estimates.

Prospects for the global IT services business are strong, with increasing acceptance of offshoring and traction in Europe. R&D services, a major service line for Wipro, is also seeing an up-tick, with the team strength now at over 13,500. Wipro has also mentioned that the environment for offshoring is looking strong. Undoubtedly, being a top-tier software company, with size, scalability, management quality and execution strengths, we expect the company to benefit. Thus, we remain positive on Wipro from a longer-term perspective.

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