Wipro Trading in Five-Star Territory

Though first-quarter earnings were disappointing, the stock continues to trade far below our fair value estimates. Read Analyst Swami Shanmugasundaram’s take on the results.
By Morningstar Analysts |  25-07-12 | 

Morningstar Analyst Swami Shanmugasundaram published a Stock Analyst Note after Wipro came out with its first-quarter earnings, reproduced below. Registered Morningstar users can read the complete analysis, which includes our fair value estimate on the stock, by downloading the PDF report from the link at the end.

After reporting a series of improved results since reorganization last year, Wipro seems to have hit a pause as it gave muted guidance (flat sequential growth) for its seasonally strong fiscal second quarter.

With the company continuing to report solid improvements in other aspects of the business, including a higher client mining rate and employee retention rate, we believe this is just a temporary pause and not a reversal from the current trend.

Accordingly, we plan to maintain our fair value estimate for the company. Wipro's first-quarter revenue increased 12% year-over-year and flat sequentially on a constant currency basis to $1.51 billion.

With the global environment in a flux, discretionary IT spending remained tight, which affected Wipro during the quarter. The pain was more severe in the company's financial services industry vertical, which derives a considerable portion of its revenue from investment banking firms.

As capital markets remain subdued, we think this trend will likely continue in the near term. On the other hand, Wipro reported solid numbers in the energy & utilities vertical and in its analytics practice, both of which reported 30%-plus growth.

Wipro's recent investment in its client mining initiatives continues to yield solid results as the company witnessed higher revenue contribution from its top five and 10 clients.

The company reported overall decline in total number of active clients and management noted that this was intentional as Wipro is trying to disengage from smaller clients that aren't strategically important. In our opinion, this was a good move as it should help Wipro to devote more time on client accounts that are strategic. In the past, Wipro is known for the breadth, not the depth, of its client base.

Wipro's operating margin during the quarter came in at 21%, up 30 basis points compared with last year.

Though currency fluctuation provided a 310-basis-point tailwind during the quarter, the company used part of that to absorb annual wage increases (given out in June) while the rest was reinvested in the business.

Wipro benefited largely from the recent depreciation of the Indian rupee against the dollar as the company was able to absorb reinvestment costs with minimal impact to margins.

Without the currency tailwind, the company would've still been able to offset the negative impact of wage increase on margins (leveraging employee utilization rates) but not the reinvestment costs. The company's utilization during the quarter stood at 77.9%, down from 81% at the end of the first quarter of last year.

Though utilization dropped by more than 300 basis points compared with last year, it is still within the company's historical range. We would be worried if the utilization rate goes below 75%.

Despite a weak demand environment, management noted that they plan to honor the commitments made to university graduates who received an offer from the company over the course of the last year. While this may impact operating margins in the short run, we believe it's a good move.

As Wipro competes with other Tier 1 players to hire talented young engineers, it is essential that it fulfills its commitments and maintains relationships with the schools.

Registered Morningstar users can download the complete Analyst Report here.

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