Excerpts from Gilford Securities analyst Ashish R. Thadhani's recent note to clients on Wipro Limited (NYSE:WIT):
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WIT: Trimming Estimates
Investment Conclusion. Based on a more cautious revenue outlook and significant non-operating adjustments (interest income and tax- rate) – mitigated by better near-term operating profitability – we are reducing our estimates as follows: fiscal 2009 EPADS to $0.59 on revenue of $6.056 billion (22% YoY growth) from $0.60 on revenue of $6.177 billion; and fiscal 2010 EPADS to $0.70 on revenue of $7.418 billion (23% YoY growth) from $0.73 on revenue of $7.686 billion. Our estimates imply 24%/11% compound revenue/EPS growth in calendar 2007-09 – after factoring a one-year extension in the “STPI” tax holiday to March 2010.
Recent price weakness can be attributed to subdued guidance and renewed concern over the U.S. IT spending environment (59.8% of revenue). Nonetheless, we are maintaining our $14.50 target price. In 12-months, this would correspond to 20x forward EPS of $0.72 – a premium to the current valuation (18x). While recent deterioration in the macro environment does present short-term challenges, we believe that this scenario could also serve to accelerate offshoring initiatives.
1Q09 Results. EPADS of $0.13 vs. $0.12 a year ago on revenue of $1.389 billion (35% YoY growth) matched our $0.13 estimate on revenue of $1.379 billion. Results included a sizable $16 million net currency translation/hedging loss (-0.9 cent EPS impact) and a higher- than-projected tax-rate. Still, operating income rose 35% YoY and exceeded our estimate by 8%. Highlights included 3.5% QoQ organic revenue growth in the IT Services segment (based on realized and not quarter-end exchange rates); resilient growth in the U.S. region (+4.2% QoQ and +36% YoY) and Financial Services segment (+5.6% QoQ and +47% YoY); improved operating metrics such as price realizations (+5% YoY attributed to performance on fixed-price projects and non- linear initiatives) and employee attrition (-350 bps YoY); and aggregate TCV of ~$500 million that should enhance intermediate-term visibility, including three wins in the $50-100 million category.
Takeaways. Wipro noted significant economic uncertainty and ongoing turmoil in the Financial Services segment while providing 2Q09 IT services revenue guidance of 2.0% QoQ and 27% YoY growth; uninterrupted activity for “business-as-usual” work (55-60% of revenue), client circumspection on discretionary projects (20%) and greater receptiveness toward cost rationalization and transformational initiatives; a better outlook for 2H09 vs. 1H09 driven by ramp-up of recent wins and a healthy deal pipeline; stable pricing with increased interest in outcome-based models (six clients); and likely moderation of annual offshore salary increases to 8-9% vs. 12-13% in prior years.
Revenue at the core Services segment advanced 35% YoY to $1.039 billion but fell short of our $1.058 million estimate due to a currency distortion. Growth was driven by the Infrastructure Management practice (76% YoY), Manufacturing & Healthcare vertical (48%) and non-U.S./European regions (60%). Operating income of $228.0 million (16.4% margin) surpassed our $211.2 million estimate (15.3% margin) driven by a higher margin in the Services segment. Profitability on a QoQ basis was hurt by seasonal visa expenses and a new RSU program (50 bps). In the reclassified IT Services segment, operating margin dropped slightly to 19.3% from 19.5% a year ago. Near-term, Wipro expects a stable operating margin in spite of annual offshore salary increases in 2Q09. Available levers for offsetting annual wage pressure comprise pricing, employee/offshore-mix, utilization and acquisition performance.
Hourly price realizations averaged $70.12 for onsite work (up 3.9% QoQ and 5.4% YoY) and $23.79 for offshore (up 3.0% QoQ and 4.5% YoY). Billed volume rose 2.2% QoQ and 24% YoY. Utilization (excluding trainees) stood at 78.3% vs. 75.2% a year ago. Higher-margin offshore work contributed 46.1% of service revenue vs. 45.8% in the March quarter. Global headcount rose just 0.1% QoQ and 16% YoY to 95,675 in June. Attrition improved to 16.6% from 20.1% a year ago.
By vertical, Technology, Media & Telecom ranked largest (31% of IT Services revenue), followed by Financial Services (25%), Manufacturing & Healthcare (19%), Retail & Transportation (16%) and Energy & Utilities (9%). Top-10 clients accounted for 20.9% of IT Services revenue, up from 20.8% in the March quarter. Wipro has 14 clients (vs. 11 in March) with an annual revenue run-rate of $50+ million, 33 (vs. 33) with $20-50 million and 33 (vs. 36) with $10-20 million. Wipro added 31 new IT Services clients – including four from the Fortune-1000 – compared with 48 in the immediately prior period. It exited the quarter with an active roster of 928, up from 927 in March.
Wipro generated CFFO of $231.5 million (or $0.16 per ADS) in the quarter. Major outflows comprised capital expenditures ($98.8 million). Wipro exited the quarter with net cash of $158.9 million, down from $187.5 million on March 31. Accounts and unbilled receivables slipped to 80 DSOs from 76 in March.
Highlights from Analyst Day Presentation in New York
Indian IT+BPO exports ($40 billion) represent only 2.3% of global technology spending ($1.8 trillion).
- Newer service lines. These comprise Testing, BPO, Infrastructure Management and Package Implementation, which recorded 36-49% YoY growth in fiscal 2008 and contributed 48% of total revenue vs. 38% in the preceding year.
- The largest third-party R&D business worldwide (18K employees). Wipro caters to the design and innovation needs of leading wireless, imaging, computer and semiconductor manufacturers.
- Wipro Infotech, a pioneer in the emerging Indian and Middle-East markets with annual revenue approximating $1 billion.
- Recent acquisitions valued in excess of $1 billion that have substantially enhanced domain competence and global reach.
- Assemble a comprehensive portfolio of outsourcing services.
- Increase focus on larger, more complex engagements.
- Enhance near-shore capabilities in response to client requirements.
- Leverage consulting to accelerate growth.
- Partner with global technology leaders to create solutions, e.g., Cisco (NASDAQ:CSCO), EMC (NYSE:EMC), Microsoft (NASDAQ:MSFT), SAP (NYSE:SAP) and Oracle (NYSE:ORCL).
WIT shares are suitable for aggressive investors. In our opinion, principal risks include the following: U.S. slowdown; rising offshore salaries; appreciation of the Indian currency, which would translate into higher expenses incurred in rupees; correction in the Bombay Stock Exchange and/or U.S. markets; political opposition in the U.S.; and geopolitical uncertainty in the Indian subcontinent.
I, Ashish Thadhani, certify that all the views expressed in this research report accurately reflect my personal views of the subject companies. I certify that I have not and will not receive compensation with respect to the issuance of this report.