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In-line performance but DXC uncertainties remain

* Q3 performance came in line with expectations, with net revenue rising 1.6% QoQ to Rs24.7bn on strong growth in the revenues of the Direct business. EBITM expanded 25bps QoQ to 16.4%. Adj. net profit grew 8.8% QoQ to Rs3.3bn on account of lower taxes.

* Direct revenue grew 5.1% QoQ (5.3% CC) to Rs20.8bn. Broad-based revenue growth momentum, robust deal wins (US$247mn in Q3; US$867mn in 9MFY21, up 64% YoY) and healthy deal pipeline (up 49% YoY) impart confidence on growth sustainability.

* DXC revenue declined 17.9%/39.2% QoQ/YoY to Rs3.2bn (-18.2%/-42.2% CC). Although DXC revenue run-rate fell below MRC in Q3 (12% lower), the company expects a catchup in next 3 quarters. There is a fall-back provision in place if revenue falls short of MRC.

* Strong traction in the Direct business and robust deal intake augur well for revenue growth; however, continued weakness in DXC and volatility in the Digital Risk business remain key risks. Maintain Hold with a revised TP of Rs1,570 (Rs1,560 earlier) on 18x FY23E EPS.

What we liked? Broad-based growth, continued traction in the Direct business and deal intake

What we did not like? Continued decline in DXC revenues (-18.2% QoQ CC)

Strong operating performance: Net revenue grew 1.6% QoQ to Rs24.7bn, based on the traction seen in the Direct business. Mphasis signed deals worth US$247mn (up ~31% YoY; 71% of deal TCV from new-gen areas) in Q3. The company is witnessing a steady increase in deal size and tenure (avg deal size grew to US$67mn in Q3FY21 from US$31mn in Q3FY20). It has signed net new deal wins of US$1.1bn on a TTM basis, providing considerable revenue growth visibility, as the Direct business has historically exhibited a high correlation (0.84) between revenue conversion and deal TCV. Management remains confident of continuing the revenue growth trajectory on continued traction in the Direct business, solid deal-win momentum, steady progress in client mining across buckets, wallet share gains across large clients and consistent new client wins despite DXC weakness. EBITM expanded 25bps QoQ to 16.4% in Q3. The company retained its EBITM guidance of 15.5-16.5% for FY21 as it looks to invest some of the cost savings back into the business.

Uncertainties in the DXC business remain: DXC revenues declined 17.9% QoQ to Rs3.2bn (-18.2% CC) and contributed ~13% of overall gross revenues in Q3. DXC revenue run-rate fell below MRC in Q3 (12% lower); however, management expects a catch-up in revenue in the next three quarters (annual MRC ~US$200mn). Mphasis has fall-back provisions in place if the revenue falls short of the MRC. Mphasis remains committed on ensuring its relationship with DXC and has reaffirmed its strategic partner status with DXC. The focus remains on building visibility beyond the MRC tenure.

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