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Mphasis stock is up three per cent in two sessions after the company posted better than expected results for the third quarter ended July 31 (its year ends in October). This takes the total gains to about seven per cent in the past one month, in-line with the BSE IT index's performance but way ahead of the two per cent fall witnessed by the Sensex.
While the rupee depreciation and improving demand environment has benefitted all IT stocks in the past month, analysts believe the trend is likely to remain positive. For Mphasis, analysts expect the company's prospects to remain good on strong traction in non-Hewlett Packard (HP) business. Also, its acquisition of Digital Risk (provides risk, compliance and transaction management solutions in US residential mortgage market) in November 2012 has also improved revenue visibility. This traction assumes significance given that HP (which forms about 41 per cent of revenues) business continues to fall. The company's July 2013 quarter earnings (announced on August 29) was ahead of Street expectations despite weakness in HP business.
"A steep shift in the business mix in favour of direct channel could indicate that the worst is behind on the revenue growth trajectory for Mphasis. Strong growth in Digital Risk business also aids improvement in the revenue growth trajectory", says Madhu Babu, IT analyst at HDFC Securities. The analyst has upgraded Mphasis to Neutral from Sell owing to improving business mix and reasonable valuations.
The stock currently trades at 10.8 times FY14 estimated earnings (year end is October), which is in-line with peers. While Mphasis' strong cash kitty of Rs 1,780 crore and dividend yield of four per cent are some positives, on the flip side, growth is likely to come at the cost of margin dilution. The company is expected to invest most of the gains from rupee depreciation in sales and marketing to increase deal wins in the non-HP business. Also, Digital Risk's margins are lower than that of Mphasis and will pull down overall margins as Digital Risk will be the key growth driver going forward. In this backdrop, analysts believe investors may consider the stock on correction.
July quarter: Direct channel drives growth
Mphasis' July quarter results were driven by strong traction in the non-HP/direct business. Revenues and net profit stood at Rs 1,534 crore (up 9.6 per cent sequentially) and Rs 193 crore (up 9.1 per cent) respectively. Its overall volume growth stood at 3.4 per cent. HP revenues fell by 0.7 per cent sequentially and the management expects this fall to continue for next few quarters as well. HP now accounts for 41 per cent of total revenues versus 57 per cent last year. Analysts believe HP could form about 38 per cent of total revenues by October, and this should help in further lowering its client concentration.
Positively, Mphasis' non-HP or direct channel revenues grew by a robust 18 per cent sequentially to Rs 81 crore and now form about 59 per cent of revenues. Full impact of Digital Risk consolidation (up 11 per cent) fuelled growth of the direct channel.
Management continues to focus on growing the non-HP segment and expects it to grow by 15 per cent this fiscal. Among regions, North America will be the key growth driver. Mphasis won a $100-million deal in the February-April 2013 quarter and expects this deal to ramp going forward. The company added 10 clients in the Direct Channel in the quarter gone by.
Rupee depreciation and reduction in loss-making projects more than offset the impact of wage hikes in the quarter. Consequently, Ebit margins improved by 110 basis points sequentially to 15.8 per cent. While management expects margins to be between 15 and 18 per cent, analysts beg to differ.
"We believe Ebit margins will be under pressure given limited levers in utilisation rates and investments required to drive non-HP business. We have assumed Ebit margins to decline by 70 basis points over next two years to 14.8 per cent," says Pratish Krishnan, IT analyst at Antique Stock Broking.
