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Direct growth moderates; margins resilient

Mphasis’s 1QFY23 report suggest growth moderation in the Direct Business (2.4% QoQ c/c) resulting in a modest 2% QoQ c/c growth, lower than expectations. However margins surprised positively with 10 bps QoQ improvement aided by revenue mix, pricing benefits and optimisation on subcontractors. Net new Order bookings at USD 302 mn were decent with company suggesting growth acceleration through the rest of FY23 along with ‘positive margin bias’ as it looks to optimise offshore utilisation over the next few quarters. We reign in revenue growth assumptions to factor additional cross currency headwinds and subdued growth in 1Q resulting in 2- 5% EPS cuts across FY22-25E. We also cut our TP to INR 2,600 (V/s 2,870 earlier)based on 25xJune’24E EPS (inline with target P/E for LTI-Mindtree). 1QFY23 marks an aberration to an otherwise consistent predictable and diversified growth profile for MPHL. PSYS and MPHL remain our BUY’s amongst Tier II techs

* Direct channel slows down resulting in modest growth at the overall level: Mphasis reported a modest 2% QoQ c/c revenue growth for 1QFY23 (1.2% in USD terms) reflecting sharp moderation in growth in the Direct Channel(+2.4% QOQ cc) in comparison to the 7%+ CQGR witnessed here in the past 6 quarters. Direct Channel performance was subdued due to the mortgage led weakness in Digital Risk and delay in ramp ups in a few European deals that resulted in muted growth in BFSI vertical (-0.3% QoQ in USD terms). Margins however held up quite well, up 10 bps QoQ at 15.3%, within the target band of 15.25-17% despite industry wide supply pressures aided by offshore shift in Applications as well as moderation in sub contractor usage which resulted in muted headcount increase at the reported level. Net new Order wins at USD 302 mn were decent with company winning another large USD 60 mn TCV win at a top BFS client in 2QFY23 YTD. Offshore and onshore utilisation went up by 200 bps QoQ and 100 bps QoQ during the quarter aiding the margin performance.

* Management remains hopeful of growth acceleration through FY23;upward bias on margins: Mphasis expects growth to improve through the rest of FY23 citing confidence in order booking and demand trends despite macro volatility. Mphasis remains confident of ‘market share gains’ across customer tiers and verticals given it’s focus on transformation opportunities. Company suggested that despite the solid order bookings through the past few quarters, it’s pipeline is up 6% QoQ and 10% YoY. Further Mphasis sees an upward bias on margins as it is focused on improving utilisation and improving the billability of the strong hiring done in recent quarters along with pricing strength, growth leverage and pyramid.

* Cut EPS by 2-5%; retain faith in ‘best in class’ client metrics and margin resilience: 1Q miss and additional cross currency headwinds drive moderation in USD growth assumptions and 2-5% EPS cuts across FY23-25E. We reduce target multiple 1 notch to 25x(V/s 26x earlier, in line with Target P/E for LTI-Mindtree) resulting in TP of INR 2,600. We continue to like MPHL for the broad based and ‘best in class’ client metrics though note that MPHL remains vulnerable to moderation in IT spending in financial services.

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