MphasiS Limited - Well geared for growth: BUY - Antique

We hosted investor meetings with MphasiS management on Monday. Management meeting reinforce our view that earnings trajectory for the company set to improve post two years of decline. Company has strengthened its leadership team and invested in sale and marketing (6% revs vs. 5% last year) which should help fuel growth. Management focus is on growing non HP revenues 1.5x industry rates over next one to two years.

Share of HP revenues likely to reduce from 38% to 31% over next two years and concentration could be lower if company pursues inorganic initiatives. Overall MphasiS has potential to grow its non HP business to USD1bn over next 3-4 year vs. USD540mn currently. While there are headwinds in Digital Risk (US mortgage), impact likely limited in our view. Forecast EPS of INR39 for FY15E and INR47 FY16E. Stock trades at 10x FY15E and 8x FY16E. Retain BUY for target price of INR520.

Key highlights

Focus on Non HP... significant investments in S&M/ senior leadership team

Management reiterated focus on growing Non HP business (63% revenues) by 1.5x industry levels. Company has strengthened leadership team and invested in S&M to fuel growth. Key recent hires include senior leader (ex HCL) to head large deal, senior leader from WIPRO IMS to head IMS business, senior person from Accenture to head International BPO. Its deal pipeline has improved with four large deals (USD50mn+) under discussion. Management hopeful of a few closure and ramp up from 3QFY15 onward. Share of HP likely to decline to 31% by FY16E in our view.

Margins to improve by 200-300bps over next 2-3 years

Management indicated that it has short term and medium term levers to improve margins. In the short term margins likely to benefit from non recurrence of hedging losses of INR1bn reported in revenue line last year and non recurrence of write off related to loss making India business. Also adoption of lean delivery model, ramp-down of low margin domestic business, increasing contribution of fixed price/outcome based deals, change in the hedging policy, among other initiatives are likely to result in higher margins. Management expects operating margins to improve by 200-300bps to 17%-18% over next 2-3 years.

Digital Risk... headwinds in US mortgage market

Digital Risk contributed an estimated 18% to revenues during 1QFY14. Management indicated that US mortgage industry likely to be volatile in the short term given improving interest rates in US. However it has recently shifted ~700 employees to temporary category which should help protect margins. While near term growth likely to be subdued, it expects growth to rebound led by recovery in US mortgage market.

Valuations & outlook

We forecast EPS of INR39 and INR47 for FY15E (March end) and FY16E. Stock is trading at 10x FY15E and 8x FY16E which is attractive. FCF generation likely to be strong with FCF yield of 9% FY15E. Reiterate BUY with target price of INR520, upside of 34%.

Source : Equity Bulls

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