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Mphasis

Revenue slows on delayed ramp-ups; TCV and margins improve: Buy

In Q3, Mphasis undershot peers with its sequentially flattish IT services (82% of revenue). The weakness arose from furloughs and delayed rampups in deals won previously. It did well, however, in its key strengths such as TCV (net new $401m) and client mining (first client moving to the $200m bracket), keeping alive revenue-acceleration hopes. BPM (18% of revenue) reflected weakness in Mortgages (~50% of BPM) though industry volumes have started stabilising in the last 2 months. Margins are trending up; to retain pace as revenue growth returns and utilisation/offshore improve. The weak Q3 leads to our ~4% cut in estimates and 3% in the target.

Another quarter of strong deals, weak growth. Mphasis’ ability to secure TCV was strong (new TCV: $401m, up 20% y/y; TTM at $1352m, up 2%) but conversion to revenue was tested again by furloughs and delayed ramp-ups in IT Services ($352m, up 1% q/q, 13% y/y). The slower-environment impact was harder for Mphasis than for peers (industry growth: 2% q/q, 9% y/y). The company expects to regain pace as the furlough impact fades and ramp-ups begin.

Digital Risk 8.8% of revenue, down 35% y/y. The DR division is ~50% of the BPM service line and one of the key reasons for Mphasis' slowing growth. Its contribution, however, has shrunk considerably in the past one year, and US mortgage industry volumes appear to be stabilising in the last couple of months. Therefore, we expect reduced drag from DR from Q4.

Profitability higher, operating metrics support further expansion. Mphasis’ Q3 EBIT margin was 16%, up 52bps q/q, 168bps y/y. Key operating levers like offshoring (by revenue) and utilisation were up sequentially and offer further tailwinds. Reported margins would improve from Q1 as hedging losses subside. We expect ~16% EBIT margins by FY25, leading to a 12% EBIT CAGR.

Maintaining a Buy. We cut estimates by ~4% and target by ~3% on delayed recovery in the core business. We expect Mphasis to start matching peers’ growth rates from Q1 FY24, and value it at 25x FY25e EPS (23x earlier), slightly below LTIM, on better portfolio mix resulting into lower volatility in performance. Our new TP is Rs.2,820 (Rs2,900 earlier). Risk: Slowdown in top US BFSI accounts.

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