Wipro reports a steady revenue growth after a sequential decline in Q1 revenues
Net profit was higher than expectations on better operating margins and a drop in tax rates
Blessed is he who expects nothing, for he shall never be disappointed," said the English poet Alexander Pope.
Investors in Wipro Ltd will not only be not disappointed, they will be quite pleased with the company’s September quarter results.
While revenue growth was more or less in line with what analysts expected, at 1.1% sequentially in constant currency terms, profit margins were better than expected.
What’s more, there was a surprise drop in the effective tax rate in the second quarter of fiscal year 2020, and the company now expects an effective tax rate of about 20-21% on an annual basis. This is lower than analysts’ estimates of a 22-23% effective tax rate for FY20 and FY21. As a result, earnings estimates are expected to be upgraded by analysts.
Wipro expects its tax rates to drop as a result of the government’s cut in minimum alternate tax rates. This sets it apart from other software services companies who have decided to stay with the previous tax regime, and hence won’t see an increase in earnings estimates as a result of the government’s tax cut.
This comes against the backdrop of a massive underperformance by Wipro shares in the past six months. While the Nifty IT index fell by 5.6% during this period, the company’s shares have slumped by 15.3%. Wipro’s shares were trading at only around 13 times FY21 estimated earnings, far lower than the more than 20 times valuation in the case of Tata Consultancy Services Ltd (TCS). “Given the rock-bottom expectations from the company, its performance will be cheered by investors," says an analyst at a domestic institutional brokerage firm, on condition of anonymity.
Note that Wipro’s revenue had fallen by 0.7% in the June quarter, after which its stock posted losses vis-à-vis peers.
But while the Q2 show looks decent against the backdrop of the weak Q1 performance and generally low expectations, there are still concerns about growth. Year-on-year growth stood at merely 3.8% in Q2. Adjusted for the contribution from acquisitions, the sequential revenue guidance for Q3 is only 0-2%.
Revenue from the banking and financial services vertical fell sequentially, which is a worry for prospects for growth going forward. Besides, the steady operating profit margins in Q2 were aided by some one-off factors that may not repeat going forward.
As such, investors would do well to not extrapolate the earnings in Q2 as a sign of things to come. Wipro’s year-on-year growth rates remain far lower than those of peers, and a large differential in valuations compared to large peers such as TCS and Infosys Ltd looks justified.
But as pointed out earlier, the fact that things improved compared to the June quarter, and considering the surprise bump in earnings owing to the tax change, the valuation gap can be expected to narrow a bit.