Upgrade MphasiS to ‘buy’ from ‘neutral’ with target price of R450. We build in 15% CAGR decline in HP business for FY14 and FY16. We expect the prospects of US-based Digital Risk (DR) to improve in the next two quarters led by improvement in mortgage volumes in the US. This coupled with lower forex losses on the revenue line over the next couple of quarters should drive Ebitda margin improvement in FY16. Market concern primarily revolves around market share loss of HP (parent) and the consequent drop in subcontracted work to MphasiS. However, with HP’s renewed focus on services, a moderation in decline cannot be ruled out.
Mphasis’ underperformance is primarily on account of revenue decline at DR and market concerns on HP’s ability to win large deals. Can it be reversed? We think yes but this is likely to play out over the next two quarters.
Management expects DR’s revenue run rate to decline for the next quarter or two and settle around $120-125 million, and start growing again from there. However, over the last two months there has been steady growth in the mortgages in the US which should benefit DR in Q4FY15 and beyond. From a quarterly revenue run rate of $45 million, it is already down to $35 million and management guidance of $120-125 million suggest a cumulative decline of $5 milllion in DR’s revenues over the next two quarters, which in our view is manageable.
With Mphasis’ hedge rate moving closer to the realised rate, we expect forex losses to reduce.