Shares of Mphasis Ltd gained about 5% since its June quarter results announcement on 26 July, even as the company’s revenue and profitability lagged estimates. Healthy deal wins and the management’s confidence about growth momentum helped the stock. However, the resilience in the stock will be tested when equity markets open for trading on Tuesday. The markets were closed on Monday for Eid al-Adha.
Last week, shares of US-based DXC Technology Co., which contributes 28% to Mphasis revenue, slumped 30% on the New York Stock Exchange. The shares sank after DXC lowered its annual revenue and earnings guidance.
In an earnings conference call, DXC’s management attributed the guidance cut to currency headwinds, pressure on traditional business, and delays in cost savings and some deals.
To be sure, Mphasis transformed its relationship with DXC by moving up the value chain. This helped the company reverse the revenue deceleration trend from its top customer, as the chart alongside shows. But questions will now be raised about the sustainability of this revenue recovery from DXC. “This is a sentimental negative for Mphasis," an analyst said in an update to his clients on condition of anonymity.
As Kotak Institutional Equities pointed out in its June quarter IT sector results review note, mid-tier IT firms have a high operating leverage. The slowdown in revenue growth makes them more susceptible to profitability pressures.
The pressures can be more pronounced at Mphasis, given the challenges at DXC.
DXC’s adjusted operating profit margin softened 1.9 percentage points from a year ago to 13.3% last quarter. Order bookings also moderated.
The pressures at DXC are not completely unknown. In fact, some on the Street have been warning about this. “We remain concerned DXC Technology-led growth may prove temporary as DXC has fulfilled more than 82% of $990 million revenue commitment by 2021. As DXC’s revenue and margin have declined in reported terms, we expect pricing pressure on Mphasis," Elara Securities (India) Pvt. Ltd said in a 26 July note.
Further, Mphasis is trying to reduce its dependence on DXC and even succeeded to some extent. Even then, the recent rebound at Mphasis was partly made possible by business recovery at DXC.
With DXC now warning about renewed pressures, investors at Mphasis may turn cautious as well. “Our FY19-21 constant currency revenue compound annual growth rate (CAGR) is 12.5% and earnings per share CAGR is 13%. Any impact to business from DXC’s struggles in its current business portfolio could pose a risk to our thesis," Motilal Oswal Financial Services Ltd said in a 10 August note.