By Joseph Hogue, CFA
Even as many manufacturers bring operations back to the United States, IT outsourcing is still doing well as evidenced by Wipro's (WIT) earnings, out last week. The company presented a positive report and outlook, a rarity for the company of late, with a 24% increase in net income to $300 million on a 17% jump in revenues over the same period last year.
Investors cheered the news and sent the shares up almost 10% on Thursday, although prices came down slightly with the rest of the market on Friday. Even with the strong gains last week shares are down 16% over the last year, although they have returned 12.6% annualized over the last decade.
The company is one of the largest global IT services firms and is divided into three segments: Global IT Services, India and Asia IT Services, and Consumer Care and Lighting. The company recently announced plans to spin-off its non-IT-related segment and focus on services, which account for 86% of revenue and 94% of profits. The global market for IT services is expected to grow at an annual rate of 4.5% through 2016.
The shares now trade at 18.3 times trailing earnings, above peer multiples of about 16.4 times. There may be some strong rationale for a premium relative to the industry. The company’s operating margin of 17.5% is above 89% of peers, and the 21.6% return on equity is above 86% of the industry.
The bullish call on Wipro may come from the sluggish economy in the United States. Companies are sitting on record stockpiles of cash, but facing declining revenues for the first time in years. Much of the upward momentum in asset prices over the recovery has been due to margin expansion as companies cut their workforces and scale down to the most cost-efficient business lines.
The stable increase in jobs added up each month, but the lackluster increase in revenues describes an environment where companies will need to deeper for operational efficiency. This may very well come from increased spending on information technology and services.
Investors may want to hold off on the shares for a month or watch for a pullback to multiples closer to the industry. The looming fear of a fiscal cliff in the United States could spook investors and have businesses holding off on expenditures. It is doubtful that the U.S. will go over the cliff in 2013, but we may stumble over a small foothill of fiscal contraction. Regardless, the demand for IT services and outsourcing should grow and support Wipro into mid-2013.