Margin pressure, valuation can cap returns from Wipro

Revenue growth for FY22 should be strong, aided by the Capco acquisition

Wipro has been the best-performing stock among the big five listed Indian software companies, enriching investors with a return of 151 per cent over the past year. Though it has underperformed peers on the revenue growth front over the last few years, the turnaround in the second half of FY21 — led by record deal wins, leadership change, Capco acquisition and strong commentary on the outlook — led to sustained gains for the stock.

The company’s growth in the June quarter is also expected to be better than peers after the revision of guidance, from 2-4 per cent on a sequential basis to 8-10 per cent, including the Capco acquisition. Wipro had announced the acquisition of Ukbased financial services consulting firm Capco (annual revenue of $700 million) in March and completed the acquisition at the end of April. The deal worth $1.45 billion is its largest acquisition and shall boost the consulting segment of the financial services vertical.

Given the deal wins of $7.1 billion in the second half of FY21 and the book-to-bill ratio of 1.6 times, there is revenue visibility for FY22, with the Street estimating full-year growth of about 11-13 per cent. What can give momentum going ahead is the company’s five-point strategy of accelerating growth, strengthening partnerships, building industry-specific solutions, scaling talent, and more importantly simplifying its operating model.

While there are tailwinds, analysts highlight key risks from operations, payout ratio margin and valuation can limit the upsides from hereon. Suyog

Kulkarni of Reliance Securities says: “Progress on various acquisitions and integration of Capco, consistency of organic growth, and execution risk (as compared to the longer track record of its larger peers) are among the major moving parts which the Street will closely track.”

Further, analysts point out that unlike TCS and Infosys, which have a payout ratio of 85-90 per cent, Wipro’s payout historically has been on the lower side, partly due to acquisitions. With revenue growth improving, the Street expects the company to adopt a more rewarding payout policy and that can be a trigger for the stock.

Pressure on profitability is another issue that can affect the stock. While the company ended FY21 with a margin of 20 per cent, analysts at Motilal Oswal Financial Services expect a 200basis point moderation in the margin over FY21-23 on account of the Capco acquisition, increased employee costs, and higher investments in sales.

With travel costs expected to come back after staying muted for the last four quarters, there can be pressure on the margin. Though the double-digit growth should partly offset the cost inflation, any sharp increase in attrition will add to the wage bill and worsen the impact on profitability.

High valuation is the single biggest reason that can cap returns in the near term for the stock. Given the outsized gains over the last year, the rerating has been the sharpest for Wipro. The stock is now trading at 27 times its oneyear forward earnings estimates, as compared to its ten-year average of 15 times. Given the consensus target price of ~472 a share and the current price of ~547, the stock in the absence of new triggers can underperform in the near term.