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Weak operating performance

Mphasis delivered weaker-than-expected operating performance in Q2FY23. Gross revenue grew by 1% QoQ to USD440.3mn, reflecting continued weakness in mortgage business and impact of furloughs. Management suggested that weakness in mortgage, macro uncertainties weighing on the velocity of decision-making, and softness in select pockets are impacting the company’s growth trajectory. Mphasis added ~9% headcount sequentially in the technology services segment onsite to support deals ramp-up. Management indicated that additions were made towards the end of the quarter and revenue accrual from the same is expected in Q3FY23. Q3 is seasonally a soft quarter due to lower working days and furloughs. Although management does not foresee unusually high furloughs, these factors are expected to weigh on Q3 growth. We have cut our EPS estimates by 1.5-2.5% for FY23E-25E, factoring in weak Q2. Post the recent correction, the valuation is reasonable; however, revenue growth acceleration is missing and management has failed to inspire that confidence. We believe revenue growth acceleration will drive sustained stock performance. We maintain Buy with a TP of Rs2,600 (Rs2,650 earlier), at 23x Sep-24E EPS, considering reasonable valuation, continued wallet share gains, and a steady expansion in addressable markets with competency build-up

Result summary: Mphasis reported 1% QoQ growth in gross revenue to USD440.3mn in Q2 (1.8% CC), below our expectations of USD446mn. Direct revenue grew by 4.2% QoQ (2% CC). DXC revenue grew 1.1% QoQ (-1% CC). EBIT margin was flat QoQ at 15.3% and was 10bps below our estimates. Net profit stood at Rs4.19bn, below our estimates of Rs4.23bn, due to operating performance miss. Revenue growth was driven by BFS and Others, which grew by 5.7% and 8% QoQ, respectively, in rupee terms. TMT, Insurance, and Logistics & Transportation reported muted sequential growth in Q2. Geographically, growth was led by EMEA (5.2% QoQ), Americas (3.8% QoQ), India (2.3%), and RoW (10.4%). Mphasis signed net new deals worth USD302mn (81% of the deal wins were in new-gen services), including two large deals with combined TCV of USD110mn. Management has refrained from giving exact exposure to the mortgage business, but it indicated that exposure to interest ratesensitive segments is in single-digit percentage of overall revenue currently. Mphasis has guided for EBITM to be at 15.25-17% through the remaining two quarters of FY23. What we like: Healthy deal intake (USD302mn); strong deal pipeline (up 18% QoQ); and steady progress across client buckets. What we did not like: Operating performance miss; softness in Insurance, TMT, and Logistics; and weak cash conversion (58% in Q2 and 68% in H1).

Earning call takeaways: 1) New TCV wins momentum sustained in Q2 with two large deals (combined TCV of USD110 mn). 2) The company expects key clients to embark on vendor consolidation exercises in response to the macroeconomy and is confident that it will be a strong net gainer in such a scenario. 3) The company shared that majority of its pipeline is tribe-driven and grew 18% QoQ. 4) Management highlighted that Q2 exit utilization is ~400 bps higher than Q2’s average utilization. The company expects utilization to trend upwards and sees headroom for 300-400 bps improvement. 5) The company continues to invest in consolidating positions in select growth accounts and has witnessed continued share gains with key clients; The Top 6-10, Top-10, and Top 11-20 clients registered strong YoY growth of 29.5%, 28.5%, and 35%, respectively. 6) Benefits accruing from employee pyramid correction, higher utilization, offshoring, and pricing benefits would act as key margin levers. 7) Offshore mix improved by 150bps QoQ to 43.2%.

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