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Improvement fully priced in

The BFSI and US recoveries on track, but valuations full  

* Mphasis (MPHL)’s 1QFY25 revenue was flat QoQ in constant currency (CC), which was weaker than our estimate (+1.2% QoQ CC). Direct business grew 0.3%/4.1% QoQ/YoY in CC, aided by Insurance and BFS. The TCV jumped 80% QoQ to USD319m due to the low base of 4QFY24 at USD177m. EBIT margin stood at 15%, missing our estimate by 30bp QoQ. PAT came in at INR4.0b (up 3% QoQ) vs. our estimate of INR4.2b, led by higher SG&A and cost of delivery.

* In line with the commentary from peers, MPHL indicated that the BFS clients saw a mild recovery in discretionary spending in 1Q, and their focus is now shifting away, albeit only slightly, from the cost takeout deals to transformation and modernization projects. Deal wins in BFS improved as well, indicating a sequentially better outlook for the vertical going forward.  

* That said, we believe our CQGR assumptions of 2.3% for FY25 and 2.5% for FY26 already bake in a recovery, and we believe the upside risk to current estimates is limited.

* On the margin front, MPHL is targeting a sustainable operating (EBIT) margin within the stated band of 14.6%-16.0%, and focusing on maintaining the margin in a narrow range while investing for growth. We believe the margin will be rangebound in the near term, and meaningful improvement will be dependent on revenue growth.

* We believe the stock has fully priced in a tailwind from the US BFS clients and a rate cut cycle, and it trades at an expensive valuation of 30x 12M forward earnings. While we raise our target multiple to 27x FY26E EPS (10% premium to the five-year average), we believe there is a limited upside from hereon.

* We cut our revenue growth estimates for FY25/FY26 by 190/90bp. Over FY24-26, we expect a USD revenue CAGR of ~7.6% and an INR PAT CAGR of ~12.5%. Our TP of INR2,800 implies 7% downside. We reiterate our Neutral rating on the stock. 

Deal wins improve, revenues below estimates  

* MPHL’s revenue of USD410m, remained flat QoQ CC/up 3.8% YoY CC, below our estimate of 1.2% QoQ CC growth.  

* Direct revenue was up 0.3% QoQ CC and 4.1% YoY CC.  

* Insurance led the growth pack with 2.7% QoQ rise; BFS (~48% of revenue) grew 1.4% QoQ, while Hi-Tech was flat QoQ.

* EBIT margin stood at 15%, missing our estimate by 30bp QoQ. PAT was INR4.0b (up 3% QoQ) vs. our estimate of INR4.2b due to higher SG&A and cost of delivery.

* New TCV stood at USD319m (up 80% QoQ/down 55% YoY) vs. USD177m in 4QFY24. About 84% of the deal wins were in Gen. Services.

* Offshore utilization (excl. trainees) improved 100bp QoQ to 76%. Net headcount declined by 1,019 (-3.1% QoQ) in 1QFY25. 

Key highlights from the management commentary 

* Spending increased among customers despite a difficult environment. Investment is slowing inching up especially for transformation initiatives. There has been a gradual pick up in the client’s engagement in terms of discretionary spending, and it is seeing some green shoots.  

* Direct business: MPHL expects the deal conversion to pick up, especially the transformative deals. Further, a gradual recovery in discretionary spending is likely.

* There was a broad-based growth of 27% YoY across all chosen verticals within the US pipeline. The pipeline remained strong, even with healthy TCV wins. Onethird of the pipeline is AI-led.

* Proactive pipeline is strong. More than 90% of wins are proactive deals. There was a pickup in TCV closures. Broad-based TCV wins across verticals and client pyramid as well as conversion from TCV to revenue continued to improve. Three large deals were won, with one US100m deal in the BFS segment.

* The company is seeing early sign of recovery in its mortgage business. 

Valuation and view – Reiterate Neutral

* MPHL indicated that the BFS clients saw a mild recovery in discretionary spending in 1Q, and their focus is now shifting away, albeit only slightly, from the cost takeout deals to transformation and modernization projects. We believe the stock has fully priced in a tailwind from the US BFS clients and a rate cut cycle, and it trades at an expensive valuation of 30x 12M forward earnings. Over FY2426, we expect a USD revenue CAGR of ~7.6% and an INR PAT CAGR of ~12.5%. While we raise our target multiple to 27x FY26E EPS (10% premium to the five-year average), we believe there is a limited upside from hereon. Our TP of INR2,800 implies 7% downside. We reiterate our Neutral rating on the stock. 

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