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Motilal Oswal Report
Wipro Ltd. reported a 2% QoQ constant currency decline in revenue in the IT services business for Q2 FY24. This was at the lower end of its guidance band due to a broad-based decline in its key verticals(banking, financial services, communication, and manufacturing).
Despite healthy deal wins, the softness is expected to continue in Q3 FY24 as the company has guided for a revenue performance in the range of -1.5% to -3.5% CC. Given Wipro's broader presence in the discretionary areas, the conversion is a challenge as enterprises are cautious and are reprioritising expenditures.
Ebit margin (IT Services) was flat (+10 bp QoQ) at 16.1%, above our estimated decline of 20 bp QoQ. Q3 FY24 will have an impact from the wage hikes that will pressurize margins for H2 FY24. Revenue growth is also likely to be weak and would be unable to restrict the adverse margin impact.
Despite a healthy deal pipeline and having delivered a robust deal total contract value of $3.8 billion in Q2, the conversion remains a challenge in the near term. Q3 is a seasonally soft quarter, and the management expects the degree of impact from furloughs to be higher than the earlier trend, which led to deliver another quarter of weak topline growth guidance.
Management indicated that slower decision-making and cuts in discretionary spends should hurt Q3 FY24. We are factoring in a CC revenue decline of 4.4% in FY24E followed by an uptick in FY25E (+7.3% CC), as we expect demand recovery to come through in FY25.
In terms of margins, the company delivered an IT services Ebit margin of 16.1%, above our expectation, and at the bottom end of its comfort range. However, we expect a dip in the operating margin in Q3 due to a wage hike, followed by a sharp recovery in Q4.
Additionally, the missing operating leverage in Q3 is less likely to absorb the overall wage hike impact and weigh on the FY24 margins. We expect FY24/FY25 IT services margins to be at 14.6%/15.6%, below the management's medium-term guided range of 17.0- 17.5%, and translating into a 4.0% rupee profit after tax compound annual growth rate over FY23-25E.
We cut our FY24E/FY25E earnings per share by 8.2%/5.0% to factor in a weaker FY24E growth due to the third quarter of expected decline.
Reiterate 'Neutral' as we view the current valuation as fair. Our target price of Rs 418 implies 18 times FY25E EPS.
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