Q2 should be better than Q1; investments likely to weigh on FY20-21 margins; 2.1/3.5% cut in FY20/21e EPS; TP revised to Rs 250
We met with Wipro’s management to get a business update on the demand environment. Management indicated continued challenges in a few verticals as clients continue to slow decision-making. Weakness persists in both deal closures and deal pipeline. Moreover, the investments are likely to weigh on the margin over FY20-21.
Growth outlook muted, investments to weigh on margin
The management indicated that despite the global uncertainty there has not been sharp cut in the spending; however, the sales cycle in a few verticals have elongated. It retained a cautious stance on risk profile of the large deals and is participating in a select few. Moreover, the company is likely to make investment in FY20 (~100 bps margin impact) to strengthen capabilities in four new technologies. We see limited room for earnings upgrade. Retain Reduce rating with revised TP of Rs 250.
The management sees slowdown in decision-making in a few verticals. The uncertain macro environment is also getting reflected in weak deal pipeline and order booking; however, there is no sharp cut in spending and a few verticals are showing signs of steady growth opportunities as well. We see likelihood of sustained weaker revenue growth for Wipro in FY20.
BFSI: Weak demand outlook in European bank and other Financial Services (Capital Market) clients; however, there is no major pricing pressure despite uncertain global environment. The company’s financial performance will not get impacted by one of the ailing European Banks (no exposure) and spending cut by a large US bank (no negative impact). US banks continues to spend on digital largely led by modernisation of their legacy system. The legacy deals when renewed see pricing cut of 15-20% but there is room to mitigate it.
Consumer Business: Q1 was impacted by closure of a project; hence, will witness trend reversal from Q2. Despite financial challenges, retailers are investing in new technology to compete with online retailers like Amazon. The portfolio of offering from DesignIT is providing good up-sell opportunities.
Healthcare and Life Sciences: HPS’ financial performance has bottomed out, as many competitors have already exited the landscape; however, the growth visibility would emerge after October depending on renewal of the policy. Moreover, there is continued softness in Life Sciences vertical. Nevertheless, payer/provider market may see better growth momentum driven by deal wins.
Manufacturing: There are challenges in the vertical despite limited exposure to the automotive vertical. These challenges are Wipro-specific; however, the management expects its digital capabilities to drive better growth opportunity in CY20.
Energy & Utilities: There is moderation in growth outlook, as the vertical may see softer than company growth. Despite stable crude prices, the spending has not come through. There is muted growth outlook for Utilities vertical, as client spending continues to remain weak.
Communication: The deal pipeline looks strong with a few deals (small though) related to 5G. Wipro is gaining traction with one of the largest carriers in the US along with Tech Mahindra; however, Wipro’s gain is largely on 5G initiatives.
A few silver linings – not enough
There are a few silver linings in Wipro’s weaker-than-peer performance –
i) Growth outlook for digital (~37% of revenue) continues to remain strong. The deals in the pipeline are a mix of digital and legacy. Moreover, these deals are not about the global rollout of the digital proof-of-concept. However, there are global rollouts of hybrid cloud; ii) there are a few large deals in the pipeline; however, the company is strict about the risk profile of these large deals; and iii) client mining continues to look strong (top 10 clients grew at 10%+ YoY and top 5 clients grew 15% YoY over the last 2 years). There has been some weakness in hunting engine of Wipro.
Growth outlook for Q2FY20 is better than Q1FY20; however, the cross-currency headwind may restrict outperformance. Moreover, margin will be impacted by wage hike (two months) in the quarter.
Change in estimates
We revise our FY20/21e USD revenue to adjust for cross-currency headwinds. We also lower our margin estimates due to investments in the business to be made along with lower other income (due to completion of share buyback); hence, cut our FY20/21e EPS by 2.1%/3.5%.