Will poor Q3 earnings spoil the party of Wipro?

Market


Shares of Wipro Ltd beat those of rivals Infosys Ltd and Tata Consultancy Services Ltd (TCS) by a mile in 2021. Wipro’s stock soared as much as 85% last year, surpassing the 50% and 30% gains in the shares of Infosys and TCS, respectively, during the same span.

The steep rally in the stock and its valuation rerating came on the back of elevated earnings growth expectations. A combination of factors helped investor optimism. These were a change in leadership, a renewed growth strategy with an increased focus on mergers and acquisitions, and the overall robust demand in the Indian IT industry.

Expectations versus reality

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Expectations versus reality

But Wipro’s weaker-than-expected December quarter performance could well change the outperforming trend in the stock going ahead.

In the fiscal third quarter, Wipro’s IT services revenue growth in constant currency terms stood at 3% sequentially, below the Street’s estimate of 4.1%. Note that the quarter’s revenue growth was at the mid-point of its own revenue guidance of 2-4%, which is a contrast to the recent trends of the company exceeding the top end of the guided range.

Investors disapproved. Shares of the company closed 6% lower on Thursday on NSE. “We expect the pressure on the stock to continue for some time. The disappointment in the third quarter earnings dampens sentiment, and the trend of Wipro stock outperforming peers could reverse if the company fails to meet its fourth-quarter guidance. The company’s fourth-quarter guidance incorporates the recent acquisitions, which could lead to lower-than-expected growth,” said an analyst with a foreign research house requesting anonymity.

Note that competitors did exceedingly well on the revenue growth front in the third quarter. Infosys and TCS saw their constant currency revenues grow 7% and 4%, sequentially, exceeding consensus estimates.

In a post-earnings conference call, the Wipro management said it would continue aggressively pursuing merger and acquisition opportunities. In the December quarter, Wipro completed two acquisitions—cybersecurity consulting services provider Edgile and US-based LeanSwift Solutions—expected to boost their cloud offerings.

That apart, some analysts are also wary that Wipro’s muted large deal wins would weigh on its ability to meet growth seen by peers and keep margins stable. “Similar to Infosys and TCS, Wipro’s third-quarter deal wins were soft at about $0.6 billion, at largely similar levels q-o-q and half of Q3FY21. Wipro post-restructuring under the current CEO will likely narrow the growth differential with TCS but lag Infosys in FY22E. But over FY22-24E, Wipro is likely to lag its tier-1 IT peers. Material improvement in deal wins is key to get more constructive,” said analysts at Ambit Capital Pvt. Ltd.

“Also, higher-margin pressures at about 320bps versus 140-150bps drops over FY21-24E at tier-1 IT peers will temper EPS CAGR to 10.2% (versus ~11-16% at HCLT/TCS/Infosys),” added the Ambit report dated 13 January. CAGR is compound annual growth rate, and EPS refers to earnings per share. In Q3FY22, Wipro’s IT services earnings before interest and tax margin fell 20bps sequentially to 17.6%, which was broadly in line with analyst expectations.

Given Wipro’s rich valuations, factors cited earlier could lead to moderation in investor expectations ahead. This may widen Wipro’s valuation gap with competitors. Based on Bloomberg data, the Wipro stock trades at 25.68 times the estimated earnings for FY23. This measure for TCS and Infosys stands at 32.44 times and 30.14 times, respectively. That said, a turnaround would go a long way in further boosting sentiment for Wipro’s shares.

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