‘Reduce’ on Mphasis as FY19 valuation excessive

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October 31, 2017 5:38 AM

Mphasis reported a strong Q2FY18 with the key highlights being revenue growth of 3.7% q-o-q in CC terms and new order intake in the direct international segment of $123m.

Mphasis, strong Q2FY18, revenue growth , FY19 valuationMphasis reported a strong Q2FY18 with the key highlights being revenue growth of 3.7% q-o-q in CC terms and new order intake in the direct international segment of $123m.

Mphasis reported a strong Q2FY18 with the key highlights being revenue growth of 3.7% q-o-q in CC terms and new order intake in the direct international segment of $123m. EBIT margin was in line with expectations adjusted for the reversal in bad debt provisions. Operating cash generation though strong at Rs 2,255 million was helped by significant increase in trade payables. Key medium term revenue and profitability expectations were retained with the company expecting 1) direct core revenues to grow well ahead of the industry average, 2) HP/DXC revenues to grow atleast in line with the industry even as execution in H1FY18 was far better with revenue growth being 17.7 % y-o-y in CC terms, 3) digital risk revenues remaining in the range of $28m- $30m per quarter, and 4) EBIT margins to be maintained in the range of 14-16%.

One-fifth of the business in terms of DR, products and the India ATM business is likely to remain ex growth in the medium term, which should cap further upside to our estimates. We see the valuation as excessive at 16.4x FY19E EPS. Downgrade to Reduce.
Overall revenues increased by 3.7% in CC terms, 4.9% in USD terms and 5.2% in rupee terms in Q2FY18. Mphasis had exceeded expectations in Q1FY18 as well when the company had delivered CC revenue growth of 4.8% QoQ. Hedge gains were lower q-o-q at Rs 397 million vs `484 million in Q1FY18, leading to growth in INR revenues post hedges of 4.5% on a sequential basis.

Within the HP/DXC channel, Mphasis aspires to gradually expand its addressable market beyond DXC and to other group entities like HP Enterprise, HP Inc and Micro Focus, which currently combined constitute just ~15% of the segment revenues. However, as indicated by the sharp drop in the gross margins of the ICE vertical from 31.9% in FY17 to 17.9% in Q1FY18 and 18.2% in Q2FY18, the initial margins on the incremental revenues from the HP/DXC channel are meaningfully dilutive.

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