MphasiS Limited - Improving earnings trajectory; Upgrade to Buy - Antique

The MphasiS' stock has underperformed the IT Index by 45% due to disappointing earnings growth over the last one-to-two years. Declining revenues from top client Hewlett-Packard and ramp down of low-margin India business impacted margins and earnings growth. Post three years of decline, we expect earnings to trend up led by: 1) Strong growth in direct business led by Digital Risk (recent acquisition); and 2) improvement in margins led by adoption of lean delivery model and a improving margin profile at Digital Risk. The company is also strengthening its leadership team, which should help fuel non-HP growth.

We forecast EPS CAGR of 12% over FY13-15e vs. a 5% decline over the last two years. Consequently, free cash flow is likely to increase 17% over FY13-15e. FCF yield at 11%FY15e and dividend yield at 4.5% is attractive. The stock has the potential to re-rate to 12x. We upgrade the stock to Buy with a revised target price of INR500 per share. Our target price is at 12x fourth quarterend Apr-15e earnings.

Digital Risk growth better-than-expected

Revenue growth at Digital Risk has been better-than-expected. 4Q revenues stood at USD46m, up 50% YoY. It announced two large deals recently. Its large deal pipeline is quite healthy, with strong progress in deal closures. Growth here is largely led by a revival in the US housing markets and its leadership in offering mortgage risk and compliance management solutions. We assume Digital Risk's revenues to grow at 25% CAGR over FY13-15e, with revenue contribution increasing to 28% over the next two years from 18% at present.

HP: Concerns remain, revenue share on a decline

HP revenues declined 16% during FY13, led by a 19% decline in enterprise business. The management feels the trend is likely to continue. We have assumed a 14% YoY decline in HP revenues during FY14e and by a further 7% during FY15e. HP has been losing market share to competition in deal renewals. With HP revenues declining, share of revenues are likely to reduce to 30% by FY15e from 44% at present.

Margins: Uptick likely

The company highlighted multiple initiatives to improve margins. These include: 1) Adoption of lean delivery model (implemented in a few projects), which should help reduce delivery cost by 200bps , 2) Improving margin profile at Digital Risk; and 3) Phase-out of low-margins projects (~5% of company revenues). We forecast EBIT margins to improve 137bps to 16.7% over FY13-15e.

Valuations and outlook

The stock trades at 11.5x FY14e and 10x FY15e (quarter-end April 2015e). The stock has the potential to re-rate to 12x FY15e given 1) Improving earnings trajectory, led by growth in non-HP and margin expansion; and 2) Strong FCF generation capability. We upgrade the stock to Buy with a target price of INR500 per share.

Source : Equity Bulls

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