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Near-term pain; Medium-term growth drivers in place

* Furloughs, lesser number of working days, deferred spending, and continued weakness in mortgage (uptick in interest rates in the US) would weigh on the sequential revenue growth trajectory in Q3. Management expects Q4 growth to be better than Q3 growth.

* Exposure to the interest rate-sensitive portion of the business is in a low single-digit percentage of revenue; hence, the incremental impact will be limited. MPHL has exposure to home equity loans and Home Equity Lines of Credit (HELOC), which may come under pressure if home prices correct sharply.

* Mphasis remains confident of delivering EBITM within the guided range of 15.25-17% for FY23 (15.3% in H1FY23); however, the pace of margin expansion would be slower due to growth moderation.

* We have revised our EPS estimates by 0.1% to -2.7% for FY23E-25E, considering the revised forex assumption for H2FY23 (Rs81.5/$ vs. Rs80.25/$ earlier) and lower growth assumptions. We have rolled forward our TP to Dec-24 and lowered the target multiple to 22x (earlier 23x), factoring growth moderation. We maintain BUY with a TP of Rs2,500 at 22x Dec-24E EPS (earlier Rs2,600), considering reasonable valuation, steady wallet share gains, and expansion in addressable markets with competency build-up.

Mortgage weakness and seasonal factors to weigh on near-term growth: Furloughs, lesser number of working days, deferred spending, and continued weakness in mortgage would weigh on sequential revenue growth in Q3. Management expects Q4 growth to be better than Q3 growth. Management highlighted that exposure to the interest rate-sensitive portion of the business is in a low single-digit percentage of revenue and, thus, expects incremental impact on growth to be limited. MPHL has exposure to home equity loans and HELOC, which may come under pressure if US home prices correct sharply. Mortgage weakness and macro uncertainties may weigh on near-term growth. However, over the medium term, growth drivers are in place: a) Management highlighted tribes-led GTM strategy, competency-driven positioning, and steady expansion in competencies helped it expand addressable spending and gain wallet share across key clients, especially in new areas of tech spend. b) Mphasis’ account-centric growth strategy improves agility and responsiveness to capture growth opportunities. Scale-up of the Top-5/10 clients over the past few years and four clients contributing over USD100mn in Q2FY23 reflect the initial success of the approach. c) The company has recently hired Jayant Chauhan as head of M&As to strengthen its capabilities and offerings through M&As to accelerate growth. Net new deals intake shows growth moderation over the last few quarters (TTM deal intake TCV USD1.3bn, 4% YoY). However, the trajectory is expected to improve as the company has renewed its tribes stack recently, based on key trends and customer needs, and it is seeing a healthy deal pipeline (18% QoQ).

Confident to operate within the guided range of 15.25-17% EBITM for FY23: Mphasis has guided for EBITM of 15.25-17% in the remaining quarters of FY23. Management highlighted that Q2 exit utilization was ~400bps higher than average utilization in Q2. The company expects utilization to trend upward, but slower revenue growth may lead to gradual recovery. The company expects optimal utilization to be ~75%, factoring in the increase in fresher intake over the past few quarters. Management further indicated that attrition is moderating as supply-side pressures are easing. Management expects stable EBITM with an upward bias over the medium term, considering the benefits accruing from revenue growthled operating leverage, employee pyramid correction, and offshoring.

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