Growth in Q3 is not likely to be sustained; current valuations duly capture underperformance; ‘Neutral’ maintained
Decent growth in Q3FY20 was driven by e-commerce within Consumer and HPS within Health BU. However, given volatility and seasonality in these segments, this growth momentum is unlikely to sustain, in our view. Also, we expect vertical-specific headwinds in key verticals like BFSI given the waning impact of tax reforms and policy uncertainty due to impending elections in the US. Thus, we do not see scope for growth acceleration. We make marg inal revisions to our estimates to rebase our exchange rate assumptions. Maintain Neutral.
Growth behind and margin ahead of expectations in IT services
Revenue grew 2.4% y-y to $2,095 m (our estimate: +3%), while Ebit declined 4.5% y-y (v/s flattish expectation). PAT was down 3.2% y-y to ~`25 bn (our estimate: -2.4% y-y). Growth in key verticals like BFSI (+0.4% q-q CC) and ENU (1.2% q-q CC) was soft. However, verticals like Consumer (+7% q-q CC), Health (+3.4% q-q CC) and Manufacturing (+4.4% q-q, CC) delivered strong growth. Growth in both the key geographies (US – 1.5% and Europe – 1%, q-q CC) was lower than company growth. ROW (+4.1% q-q, CC) has driven growth due to ramp up of one large project. On an adjusted basis (for provision reversal), the Ebit margin in IT services expanded ~10bp q-q to 18.2%. This was 40bp ahead of our estimate. However, consolidated Ebit margin was ~50bp behind our estimate due to sharp margin contraction in both ISRE and products business.
Commentary on BFSI slightly better than expected
Overall demand environment has neither improved nor deteriorated compared to the previous quarter. The company is not seeing any extended timelines in terms of deal closures. In consumer BU, some sub-segments like e-commerce drove growth during this quarter. However, it expects spends around retail to be volatile. Funnel size in BFSI was significantly higher than it was last year. This gives confidence behind the optimism in this vertical.
Valuation view – current multiples duly capture fundamentals
Over the past few years, WPRO has been under-performing tier-I on growth, partly due to its higher exposure to verticals going through challenges (e.g. Healthcare, ENU). In addition, company level changes (e.g. restructuring in India/Middle East, etc.) further constrained growth. While huge capital return was a key thing to watch out for till recently, that should not be the case in the new buyback taxation paradigm. The stock trades at ~14x one-year forward P/E, in line with long-term rolling averages. We believe current valuations duly capture growth underperformance of the company.