Morningstar analyst Andrew Lange reviewed the Wipro stock recently. Here is an excerpt from his detailed analysis. You can read his views on Infosys here.
Fair Value Estimate – Rs 650
After rolling our model forward one year, our FVE remains Rs 650. Our updated financial model implies forward fiscal-year price/earnings of 17 times, an enterprise value/EBITDA of 12.5 times, and a free cash flow yield of 5%. We expect Wipro to increase its revenue around 9.5% per year (in Indian rupee terms) over the next five years as it remains focused on top-line growth.
We think the firm will supplement its organic growth in core markets such as energy, finance, manufacturing, and healthcare with acquisitions that enhance its industry expertise, skill sets, and global presence.
In terms of geographies, the European market is an obvious growth opportunity for Wipro, given the region's increasing willingness to adopt an outsourcing business model and an underpenetrated marketplace. We believe the firm will seek to increase its presence in Europe, and we expect it to use mergers and acquisitions to achieve this. We forecast a modest improvement in operating margins over the next five years (a 100-basis-point improvement) after Wipro's divestment of its lower-margin consumer care and lighting, infrastructure engineering, and other businesses. In addition, a greater focus on automation, process simplification, workforce utilization, and better acquisition integration is expected to help counter yearly wage inflation and reinvestment requirements.
Scenario analysis – Bear case
In our bear-case scenario, we assume Wipro struggles to keep up with the fast-changing IT services market and that competition eats away at the firm's ability to attract new clients and retain old ones. We think commodification of low-end services leads to pricing pressure, which erodes the company's operating margins, too. Furthermore, we forecast high employee attrition and low utilization rates. Under these conditions, we expect revenue growth to fall to the mid- to high-single-digits and operating margins to fall to the mid-teens, resulting in a fair value estimate of Rs 470.
Scenario analysis – Bull case
Our bull-case scenario assumes that Wipro successfully moves up the IT services value chain into more consulting-led transformational deals, which will benefit margins and keep commodification at bay. We also think Wipro's growth rate will benefit from significant outsourcing adoption in continental Europe. Finally, a high level of process automation is forecast to alleviate head count-related margin pressure. Under this scenario, we expect revenue to grow in the mid-teens and operating margins to improve to the mid-20s, resulting in a fair value estimate of INR 880.
Economic Moat - Narrow
High switching costs underlie Wipro's narrow economic moat. The company has decades of industry experience and a trove of loyal customers that rely on the firm to provide mission-critical business processes and IT services. Such mission-critical services allow for a deep understanding of clients' intricacies, and as a result, customers are reluctant to switch between vendors, as it could cause significant business disruption. Notably, Wipro's revenue from repeat business traditionally hovers around 98%-99%, supporting our view that the firm benefits from high switching costs.
The firm's broad global delivery capabilities, combined with its ability to offer myriad integrated services (such as BPO services, application services, and infrastructure services), set it apart from smaller rivals and help the company attract marquee global clients. In fact, Wipro has more than 1,200 global clients, of which 150 are Fortune 500 companies.
Moat Trend - Stable
Switching costs will protect the company from any notable competitive disruption for the foreseeable future. According to technology research firm Gartner, Wipro's global IT services market share has increased to the mid-20th position from the mid-30th position over the last few years (in 2015, Wipro's global market share was up slightly from 0.7% to 0.8%, year over year).
We think this market share improvement has come from organic and inorganic growth. Unless Wipro conducts large mergers and acquisitions, we do not currently see any significant headwinds or tailwinds that would cause Wipro's competitive position to change dramatically. Notably, this stable environment is supported by the long time required for competitors to build deep industry expertise and develop meaningful client relationships. Furthermore, Wipro's diverse portfolio of service offerings protects the firm from service-specific demand issues, which further insulates the company's competitive position from any noticeable downside risk.
You can read his views on Infosys here. A detailed analysis is available on Morningstar Direct.
