• SEPTEMBER 3, 2012

Wipro Ltd.: Segment Analysis

Background: More often than not, when we think of the Indian IT Services sector, Infosys and TCS are the first two names which spring up on our minds, followed by Wipro and HCL Tech, perhaps.

An investor may think that the operating fundamentals of all these companies would also be the same, as they generally offer similar services and cater to same geographies.

However, they would be surprised if they discover that while the average (onsite and offshore) billing rates of Wipro IT Services are considerably higher than that of Infosys, Tata Consultancy Services (TCS) and Hindustan Computers Limited (HCL), the benefit does not percolate down to Wipro Ltd.'s operating profit level.

This article analyses the reasons for the conundrum faced by Wipro Ltd., and hypothetically questions whether Wipro Ltd.'s shareholders have suffered because of this anomaly.

Billing rates: We calculate the average billing rates in US dollar per hour for the IT services divisions of Wipro, Infosys, TCS and HCL for FY12.

Table1: Billing rates for Wipro, Infosys, TCS and HCL
  Wipro Infosys TCS HCL
  FY12 FY12 FY12 FY12
IT Services Revenue(USD mln) 5921 6285 9852 2957
Billing rate (USD per hr) 53 43 33 38

Note: TCS person months are estimated (the information is not available due to disclosure limitations) based on 75% of year-end total employees working on projects, and utilization rates excluding trainees.

From the above table we find that Wipro's billing rate of USD 53 in FY12 is significantly higher (by nearly 40%) than the average rates of the other three companies. FY11 results also exhibit the same pattern.

Wipro Ltd.'s Profitability and Capital Employed: Readers may be aware that apart from the IT Services segment, Wipro Ltd. also has two other divisions, viz., IT Products and Consumer Care and Lighting. To learn more about Wipro Ltd. and its three divisions, we do an in-depth analysis of key financials of FY12 and the results are shown in the table below.

Table2: Analysis of the key financial parameters of the segments of Wipro Ltd.
  IT Services IT Products Consumer Care & Lighting Wipro Ltd. Total
Gross Profit Margin 32.6% 11.3% 43.3% 29.9%
Operating Profit Margin 20.8% 4.6% 11.8% 17.1%
Calculated Avg RoCE 48.1% 10.7% 18.1% 20.1%

The table above highlights the following points.

While the FY12 gross margins of the Consumer Care and Lighting (CCL) and IT Services divisions are relatively higher, 43% and 33% respectively, the IT Products's low 11% gross margin drags down the overall gross margin of Wipro Ltd. to 30%.

Then, the IT Services's strong 21% operating margin is offset by CCL and IT Products's operating margins of only 12% and 5% respectively, dropping Wipro Ltd.'s overall operating margin down to 17%.

Further, as providers of capital, investors are interested in knowing about the Return on Capital Employed (RoCE). So, we take a closer look at this critical parameter.

Return on Capital Employed (RoCE)

In the case of RoCE, the IT Services's excellent FY12 performance of 48% is again detrimentally impacted by both IT Products (11%) and CCL (18%), so that Wipro Ltd.'s overall RoCE is only 20%.

We wonder what would have happened if Wipro Ltd. had only one segment - IT Services? What would have been the incremental operating profit, if Wipro Ltd. invested only in IT Services, and nothing in the other two segments which lowered its results, (assuming that the additional investment in IT Services would have yielded more revenues from existing/new customers)? Assuming the FY12, 48% RoCE for all investments, the incremental operating profit that Wipro Ltd, would have made turns out to be Rs. 12.8 bn or 20% higher than that of the actual operating profit in FY12. For FY12, on a per share basis the increase works out as Rs. 5.12 and net of taxes, earnings per share (EPS) would have increased by Rs. 4.11 (18% of the reported FY12 EPS).

Question: Have the shareholders of Wipro Ltd. been penalized unnecessarily because of the below-par performances of the Consumer Care and Lighting and IT Products segment vis-a-vis the IT Services segment?

Conclusion: As we have pointed out earlier, among all divisions, the IT Services segment of Wipro generates the highest operating margin and RoCE. However, primarily because of the low operating profits of other segments, the combined Wipro Ltd., RoCE takes a hit.

So, we conclude that Wipro's shareholders have indeed suffered because of the below par performances of the other segments of Wipro compared to its IT services segment.

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