We hosted Wipro (WPRO IN, Neutral) on 9 June as part of the Nomura Investment Forum Asia 2022.
Near-term demand outlook robust: Wipro noted that it is not seeing any signs of demand slowdown currently in both client conversations and pipeline. However, the company highlighted that there is generally a lag between a slowdown in the broader macro environment and tech spending. Wipro noted that in the event of a slowdown, cost optimisation projects could take priority over business model change projects at clients’ end. In our recent sector report we delved deeper to explain this lag and how we think demand slowdown could be faster than consensus estimates in FY24F.
Digital a multi-year journey
Wipro noted that digital will likely be a multi-year journey as the fundamental reason leading to the acceleration of the digital transformation demand brought by the pandemic remains intact. Areas such as cloud adoption, cybersecurity and employee experience would continue to lead the growth over the next four-five years as most companies are still in the early stage of this transformation journey, while the urgency could get eased in an uncertain macro scenario.
Margins will be under pressure going into FY23…
Wipro noted that margin in the first three quarters of FY23 will be lower than its indicative range of 17-17.5% and would likely recover in Q4FY23F. Key headwinds will come from: 1) higher-than-usual wage hikes led by higher-than-usual inflation, 2) continued supply side pressure, and 3) part of COVID-related discretionary cost coming back. Tailwinds from: 1) pyramid optimisation — Wipro hired 25k freshers in FY22 and plans to hire ~40k employees in FY23F, 2) stabilising attrition (Q1FY23 would still see seasonality impact), 3) automation and cost optimisation initiatives, and 4) price increase would likely help support margin in the second half of FY23F.
…levers exist to improve margins in the medium term
Wipro noted that there are five key levers to improve margins in the medium term:
1) optimisation of employee pyramid structure, 2) sustained revenue growth offering operating leverage, 3) optimising SG&A spends (which are still higher compared to largecap peer set), 4) optimising subcon expenses, and 5) improving quality of revenues.
Capital allocation policy supporting M&A
Wipro reiterated its capital allocation policy of paying out 45-50% of its annual free cash flow to shareholders, retaining the rest for M&As, as it continues to prefer buyback over dividend. Wipro highlighted that M&As have become far more critical after strategy refresh under the new CEO, Thierry Delaporte. The company recently acquired Capco and Rizing to bolster its consulting capabilities under Thierry.
Reiterate Neutral with an unchanged TP of Rs 490
We expect Wipro to post USD revenue growth of 12.1% with 110bp contraction in EBIT margin to 17.0% in FY23F. We reiterate our Neutral rating for Wipro with our target price of Rs 490 (set at 18x FY24F EPS of ~Rs 27), based on a three-stage growth model. Wipro currently trades at ~17.4x FY24F EPS.