Wipro’s first-quarter results showed resiliency as it opened its fiscal 2021 against a backdrop of broad-based demand softness. While the top line felt the brunt of the COVID-19 economic impact, Wipro executed workforce and cost management measures to improve margins from pre-pandemic levels.
First-quarter revenue declined 4% year over year in constant currency terms. Even as Wipro saw tough demand environments in every industry, management noted stability returning to the consumer, technology, and communications verticals, which have been some of the hardest hit. The firm also showed strength in cost management to expand margins even as the top line fell. Wipro’s operating margin grew 90 basis points year over year due to improvements in utilization and offshore mix. Diluted EPS of Rs 4.19 showed 14% upside to Capital IQ consensus, aided by cost management and the firm’s share repurchases from the prior year. Fellow Indian IT giant Tata Consultancy Services expects the June quarter to have been the trough for the current demand drop, and while Wipro didn’t provide guidance, we expect to see sequential improvement in the second quarter for Wipro as demand stabilizes.
The firm continues to drive business even with over 97% of its workforce out of the office. Wipro announced the acquisition of a small consultancy in northeast Brazil in the quarter and still grew its cash position to $4 billion. This was the first quarter featuring Thierry Delaporte on the call as CEO. While he expressed a continued commitment to profitable growth, he refrained from any talk of a detailed strategy for his tenure until a later date. Nevertheless, we think Wipro’s executive team is well suited to continue steering the ship, and Delaporte’s two decades of experience at European IT competitor Capgemini will be a benefit.
Economic Moat: Narrow, Moat Trend: Stable
High switching costs underlie a narrow economic moat for Wipro. The company has decades of industry experience, end-to-end capabilities, and a trove of loyal customers that rely on the firm to provide mission-critical business processes and IT services.
Such mission-critical services require a deep understanding of clients' intricacies, and as a result, customers are reluctant to switch between vendors, as it could cause significant business disruption. This isn’t to mention the high risk to failure of such mission-critical services a customer would undertake if beginning a brand-new vendor relationship. A history of execution builds trust with customers and heightens switching costs.
Furthermore, as client relationships elongate, the value that Wipro can add to a firm grows. With deep knowledge of company processes and operations, as well as the history of such processes, Wipro is better able to build new capabilities that are completely customized. If the client relationship becomes lengthy enough, Wipro may even have a longer tenure with a customer than the customer’s own IT employees, making their knowledge base and capabilities even more integral.
As evidence of these switching costs, Wipro boasts revenue from existing customers above 98%. The firm's broad global delivery capabilities, combined with its ability to offer myriad integrated services (such as business process outsourcing services, application services, and infrastructure services), set it apart from smaller rivals and help the company attract and keep marquee global clients. In fact, Wipro has more than 1,100 global clients, of which more than 100 are Fortune 500 companies.
Fair Value Estimate, or FVE
Our FVE for Wipro is Rs 230, or $3, per share with a conversion rate of Rs 76.5 to $1. Our discounted cash flow model implies forward fiscal-year price/earnings of 14 times, enterprise value/adjusted EBITDA of 9 times, and a free cash flow yield of 7%. We expect Wipro to increase its revenue around 6% per year (in Indian rupee terms) over the next five years as it remains focused on top-line growth.
We think the firm will supplement its organic growth in core markets such as energy, financial services, and consumer business with acquisitions that enhance its industry expertise, skill sets, and global footprint. In terms of geographies, the European market is a promising growth opportunity for Wipro, given the region's increasing willingness to adopt an outsourcing business model and underpenetrated marketplace. We believe the firm will seek to increase its presence in Europe, and we expect it to use mergers and acquisitions to achieve this. Overarching all segments and geographies will be the company’s focus on digital transformation, which will become an even larger driver of revenue in the coming years.
We forecast a modest improvement in operating margins over the next five years after recent heightened reinvestment and restructuring abates. We expect a greater focus on automation, process simplification, workforce utilization, and better acquisition integration to help counter yearly wage inflation and reinvestment requirements as well, further strengthening margins.
High Uncertainty Rating
The IT services industry is highly competitive and constantly changing. Wipro needs to continually reinvest in new innovative service offerings in order to remain relevant in the marketplace and protect their market share and economic moat from competitors. Specifically, many of the firm’s lower-cost services are at risk of commoditization currently, and an inability to pivot into higher-margin businesses could erode its competitive position. Additionally, employee attrition and utilization are metrics that need to be managed closely and proactively, as these measures can have a notable impact on the firm's operating performance.
Added restrictions on immigration reform globally could eat away at Wipro’s offshore mix and compress margins. Specifically, given the large amount of revenues the company earns in North America, any detrimental change to U.S. immigration law could inflate the cost of Wipro's global delivery model, as the company relies on visas such as the H-1B.
Wipro is at risk of macroeconomic trends. A large appreciation in the rupee against the U.S. dollar would have a negative impact on Wipro's cost base. Also, negative movements in GDP and global IT spending would have a detrimental effect on the company, especially in geographies and verticals with a large portion of its revenue, like North America, Europe, and the financial services sector.
