Mphasis' cautious optimism fails to revive sentiment

In an earnings call, the Mphasis management said that the weakness in its top client account was led by softness in regional banks and cyclicality in the mortgage business.
In an earnings call, the Mphasis management said that the weakness in its top client account was led by softness in regional banks and cyclicality in the mortgage business.

Summary

A relatively higher exposure to the mortgage business remains a pain point for Mphasis.

Tier-2 IT company Mphasis Ltd continues to disappoint investors with muted earnings performance. The December quarter (Q3FY24) was not much different. Sequential constant currency revenue grew 1%, aided by acquisition, while organic growth was subdued. 

A relatively higher exposure to the mortgage business remains a pain point for Mphasis. The ongoing uncertainty around the US interest rates and its exposure to regional banks is seen as headwind. In this backdrop, the company’s high dependency on discretionary areas has weighed on its near-term growth performance, leading to weak revenue growth trajectory.

In an earnings call, the management said that the weakness in its top client account was led by softness in regional banks and cyclicality in the mortgage business. Revenue from the DXC business that caters to mortgage sector contracted sharply yet again in Q3. However, the management believes that the pressure in the mortgage business is bottoming out. Further, the management is confident of reversing the Q3 revenue impact (due to furloughs) in Q4 and expects deal conversions to improve, driving better revenue growth. The total contract value for new deals stood at $241 million in Q3 – a nine quarter low, falling 5.5% sequentially.

But the stock’s reaction suggests that the Street is not convinced. The stock has declined by over 3% since it announced Q3 result last week. Plus, earnings estimates have been revised lower. “We cut FY24-26E EPS by 2-3%, factoring-in the Q3 performance miss," said analysts at Emkay Global Financial Services.

A problem is that despite the management’s confidence of a turnaround, analysts caution that the pace of revenue recovery to be gradual, at best. “We expect the BFSI (banking, financial services and insurance) business to get weaker for a few more quarters, before any significant recovery. Till then, we expect Mphasis to under-grow and underperform its peers, on top-line as we all as on earnings growth front," said Nuvama Research report.

On the operating parameter, Ebit margin at 14.9% fell by around 60 basis points sequentially, but it was ahead of consensus estimate. Ebit is earnings before interest and tax. Margin was aided by structural benefits from the high gross margin silverline business and better execution, said analysts. 

Mphasis has maintained its margin band of 15.25%-16.25% (excluding merger & acquisition charges) for FY24, as it sees multiple operating levers. "We expect FY24 margin at 15.2%, before improving to 15.3%/16.1% in FY25/FY26," said Motilal Oswal Financial Services report. 

That said, valuation is pricey given the bleak near-term growth prospects. “Valuation at 25x FY26E price-to-earnings is comparable to Coforge (26x), which is expected to report a much higher earnings CAGR (32%) than Mphasis (11%) over FY24–26E," added the Nuvama report. 

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