Wipro posted revenue growth below estimates and internals do not give a reason to change our cautious stance, with: (i) slower developed market growth vs. peers (flat y-o-y in US, < 5% y-o-y in EU despite decent q-o-q traction); (ii) slow y-o-y growth in verticals (ex of BFSI); (iii) y-o-y growth in Digital slowed to 22% y-o-y (vs. 39% in Q4FY17) and Legacy grew ~1%; (iv) weakest exit growth in 4QF at 3% y-o-y (vs. 6-9% at peers), will make material acceleration difficult and growth differentials with peers might persist in FY19F; (v) risks to growth in Energy on insolvency at a $100mn+ client and litigation at another. We look for largely unchanged USD revenue/EPS CAGR of 5% for FY17-20F. WPRO’s stock, despite weak fundamentals and EPS cuts of 18% since Apr- 16, has been the best performer in Indian IT, up 36% in the past year, driven by corporate action (bonus/buyback) and hopes of a catch-up with industry growth, which we are not convinced about. We find the stock expensive at 17.5x/16.7x FY19/20F, a premium of 3-20% to likely better growing peers such as INFO/HCLT. Maintain Reduce, with a revised TP of Rs 270.
Q3: Below estimates on growth; large segments ex BFSI sluggish
WPRO posted constant currency (CC) revenue growth of 0.9% q-o-q (vs. estimate of 1.2%) and in-line Ebit at 17.2% (ex of $50 mn provision for insolvency of a client). It guided for 1-3% q-o-q growth in Q4, in-line with consensus but ahead of our estimate of 0.5-2.5% q-o-q. BFSI/Healthcare was strong q-o-q, while other verticals were sluggish. By region, Europe was strong q-o-q, but US was weak and slowed down to 0% y-o-y. WPRO indicated that y-o-y growth catch-up with peers could still be a year away.
Estimates largely unchanged; TP rises to Rs 270 on roll forward
We look for 5% USD revenue/EPS CAGR, Ebit margins falling 90bps to 16.2% by FY20F. Our target price rises to `270 on one-notch multiple upgrade to 13.5x (10-20% discount to HCLT/TCS and 10% discount to historical average) and roll forward to FY20F. We reset our target multiple to factor in abundant domestic fund flow and relative valuation differentials vs. the market.
Takeaways from management commentary
Healthcare: WPRO expects bottoming out in Healthcare business starting Q3FY18, though uncertainty related to ACA will continue.
Energy and Utilities: Growth in the Energy verticals was impacted by client-specific issues and restructuring in the Middle East business. WPRO expects growth to be impacted in the Energy vertical due to insolvency at a possible $100 mn client and litigation at another. Q3 revenues did not have any impact on revenues due to the client insolvency.
Guidance on 4QFY18F: WPRO indicated that CC guidance of 1-3% for Q4FY18F incorporates impact from insolvency at a customer in the Energy vertical and other commentary on verticals. WPRO indicated that catch-up on growth with peers on y-o-y growth is still a year away, though sequential growth could start to be in-line with industry.
Automation: WPRO deployed 89 unique bots at more than 275 customers totaling 2.7k instances of deployment in the run, testing and BPO services. This led to FTE savings of 1.5k in the L2 bucket.
Challenges in Legacy: WPRO indicated that while market share shift story remains intact for Indian IT, automation and productivity-led declines will continue to provide offsets and growth rates of the past are unlikely to occur in the legacy business. Secondly, large deals in the legacy business have reduced as customers decide on the newer technologies to adopt and revamp their tech stack. However, like peers, WPRO has indicated that the size of Digital deals is increasing as customers plan to take POCs and implement it on a full scale.
Estimates are largely unchanged, raise target price to Rs 270
We remain below consensus on our revenue growth expectations for WPRO. We look for USD revenue CAGR of 5% (4% organic) over FY17-20F and we expect IT services Ebit margins to fall 90bps by FY20F to 16.2% and are 50bps lower vs consensus. We expect EPS of Rs 18.0/18.8/19.7 over FY18/19/20F. Our TP rises to Rs 270 on one-notch multiple upgrade to 13.5x (10-20% discount to HCLT/TCS and 10% discount to historical average) and roll forward to FY20F. We reset our target multiple to factor in abundant domestic fund flow and relative valuation differentials with the market. The target multiple of 13.5x is at a 10-20% discount to our target multiples for HCLT/TCS.