Monday, January 23, 2023

Mphasis Ltd Weak Operating Performance; Deal Intake Remained Healthy


CMP: Rs2021  

Target Price: Rs2450

Mphasis delivered weaker-than-expected operating performance in Q3FY23. Gross revenue declined by 2.5% QoQ to USD429.4mn, reflecting continued weakness in the mortgage business and hi-tech and seasonal factors (furloughs and lesser working days) in Q3. Mphasis signed net new deals worth USD401mn (vs. USD302mn in Q2), of which ~70% is contributed by BFSI. Management indicated the deal pipeline grew by 6% QoQ/27% YoY and non-BFSI share in the pipeline increased to 44% (grew by 86% YoY) and will act as new engines of the company’s growth. 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 in the near term, although it indicated that Q4 revenue growth would be better than that in Q3. We have cut our EPS estimates by 2.7-3.5% for FY23E-25E, factoring in the Q3 performance miss. Management failed to inspire confidence on sustained revenue growth acceleration, which would weigh on the stock’s performance in the near term. We maintain Buy with a TP of Rs2,450 (earlier Rs2,500), at 22x Dec-24E EPS.

Result summary: Mphasis reported a 2.5% QoQ decline in gross revenue to USD429.4mn in Q3 (-2.5% CC), below our expectations of USD440mn. In rupee terms, direct revenue was flat QoQ (-2.8% CC), while DXC revenue grew by 3.1% QoQ. EBIT margin was flat QoQ at 15.3% and was 40bps below our estimates. Net profit stood at Rs4.12bn, below our estimates of Rs4.32bn, on account of operating performance miss. Revenue growth was driven by logistics and transportation and others, which grew by 2.3% and 3.4% QoQ, respectively, in rupee terms. TMT, insurance, and BFS reported muted sequential growth in Q3. Geographically, growth was led by EMEA (2.9% QoQ) and India (4.1%), while growth in Americas was flat QoQ and RoW declined sequentially by 3.1%. Mphasis signed net new deals worth USD401mn, the second highest on record, of which 74% are in new-gen services. The company won five large deals in Q3, which is the highest ever on record to date. Mphasis has guided for EBITM to be at 15.25-17% in Q4. What we like: Robust deal intake (USD401mn); strong deal pipeline (up 6% QoQ, 27% YoY); and steady progress across client buckets. What we did not like: Operating performance miss; softness in BFS, insurance, and TMT; and weak cash conversion (OCF/EBITDA at ~60% in Q3 and ~65% in 9M).

Earnings call KTAs: 1) Mortgage business (Digital Risk) revenue contribution is ~8.8% of Q3 revenue. Within DR revenue mix, contribution of the most vulnerable segment, origination, declined to ~20% of DR’s revenue and is below 2% of the company’s overall revenue. 2) DXC’s contribution to the overall revenue is ~4.8% and, given the low and declining contribution of DXC to the revenue, the company’s overall growth is reflective of the direct business growth. 3) The company shared that most of its deal pipeline is tribe-driven and grew by 6% QoQ. 4) Management indicated that the largest deal signed in Q3 was from one of the top-10 customers. The company signed a large deal in the healthcare vertical, which was signed with a new customer. 5) Utilization (excluding trainees) was at 74% and management expects it to trend upwards and sees headroom for 300-400 bps improvement. 6) The company continues to invest in consolidating positions in select growth accounts and has witnessed continued share gains with key clients; Top-5 and Top-10 accounts grew by 20.6% and 19.8% YoY, respectively. 7) It added 4 new clients in Q3. NCA continues to lead growth in direct and grew 30% YoY. 8) Offshore mix improved by ~160bps QoQ to 44.8%.

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