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Morningstar | BFSI Bolsters Wipro's 2Q Results, Digital Services Remain Big Focus; Shares Near Fair Value

Wipro reported a decent second quarter with the firm posting IT service revenue slightly above company guidance after adjusting for currency movements. Like the company’s first quarter, the important banking, financial services, and insurance business (about 30% of total revenue) buoyed the quarterly revenue performance. We were expecting such a performance from the BFSI segment, though, because of peers such as TCS and Infosys seeing similar trends. We believe the health of the BFSI market is a key performance indicator for the offshore IT services market and will continue to buttress short-term weakness in other parts of Wipro's business. With Wipro recently selling its hosted data center services business to Ensono, we think this move indicates a concerted effort by Wipro to exit legacy lines of business to focus on higher growth digital transformation opportunities. To that end, we saw strong sequential growth of 13.4% for the digital services business and it now constitutes 31.4% of total revenue (up from 28% in the first quarter). We continue to see Wipro providing the requisite digital services for existing sticky customers, which will help to drive moderate long-term top line growth. After the quarter, our view of the company remains unchanged and we reiterate our INR 325 per share fair value estimate (our U.S. dollar fair value moves to $4.45 from $4.75 based on an updated USD/INR rate) and narrow economic moat rating. With shares trading at our fair value, we’d seek a wider margin of safety before investing in the name.

For the quarter, gross revenue increased 8.3% year over year to INR 145.4 billion, while IT services revenue rose 10.4% to INR 143.8 billion (on a non-GAAP constant-currency basis IT services revenue increased 5.1% in U.S. dollar terms to $2.04 billion). In U.S. dollar constant currency terms, the BFSI business posted year over year revenue growth of 16% and was the standout performer for Wipro. The consumer and technology businesses also performed moderately well. However, the firm experienced revenue declines across the communications, health, and manufacturing businesses, highlighting the mixed nature of the company’s results through the fiscal year thus far.

In terms of operating margin, Wipro's reported margin declined 270 basis points year over year to 14.6%. Nevertheless, this reported margin included a significant client-related impact. On an adjusted basis (excluding the client impact), the firm’s operating margin expanded 80 basis points year over year to 18.1%. After a depressed margin profile over the past five quarters due to heightened reinvestment and restructuring, we expect a gradual improvement in the firm’s normalized operating margin. Greater focus on automation, process simplification, workforce utilization, and better acquisition integration is expected to help counter yearly wage inflation and reinvestment requirements.