MPHASIS Pricing revisions to be the key:: Edelweiss

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􀂃 Results marginally lower than estimates; muted compared to peers
Mphasis’ results were marginally below our estimates; operating margin
(EBITDA) was lower due to increase in SG&A costs. Revenues, at INR 13.5 bn,
grew 5.2% Q-o-Q (4.9% volume growth, 0.5% pricing and negative 0.2%
currency impact). Net profits, at INR 2.84 bn, grew 4.7% Q-o-Q, led by lower
effective tax and higher forex gain. Mphasis’ quarterly performance was below
par compared with peers in terms of revenue and operating profit growth.


􀂃 Single vertical-led growth; outlook muted in remaining verticals
Except telecom, all other verticals reported flat revenues, which is a key concern.
All of the incremental revenues (INR 600 mn) over the previous quarter came from
telecom (13% of revenues); the vertical regained revenues it had lost last quarter,
apart from new revenue bookings. Further, management indicated positive growth
only from BFSI vertical, implying muted outlook in the remaining verticals.

􀂃 Pricing revision, direct business investments to strain margins
We see a few challenges for Mphasis: (a) increase in sales investments to grow
its non-HP business (currently only 30% of revenues); (b) downward pricing
revision (currently ongoing and likely to be effective from November 01); and (c)
salary increases due to high attrition (30% in application and 25% in ITO).
Improvement in utilisation and efficiency may provide only marginal cushion. We
estimate 170bps margin decline in FY12E due to the above factors.

􀂃 Ramp-up of direct business could be a bigger challenge
Mphasis is currently focusing on growing its direct business, particularly in the
highly competitive BFSI space. The key challenge here is the step-up required in
sales spend and lower than industry pricing that it may have to give to compete
(thus additional pressure on margins). Further, we wonder whether the change
in volume visibility from HP (downward) is resulting in greater focus to grow
direct business.

􀂃 Outlook and valuations: Muted earnings growth; maintain ‘REDUCE’
We estimate meager 1.8% earnings CAGR over FY11-13E, driven by margin
decline and significant rise in effective tax rate. Mphasis is currently trading at a
P/E of 12.1x and 11.5x FY12E and FY13E, respectively. We see flat earnings
growth and lower predictability resulting in continued underperformance of the
stock. We maintain ‘REDUCE/ Sector Underperformer’ on the stock.