Mphasis (MPHL IN) Modest Revenue and margin miss. Q2FY19 Result Update. Rating: ACCUMULATE CMP: Rs1,068 TP: Rs1,220.

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1 (MPHL IN) Rating: ACCUMULATE CMP: Rs1,068 TP: Rs1,220 October 21, 2018 Q2FY19 Result Update Change in Estimates Target Reco Change in Estimates Current Previous FY19E FY20E FY19E FY20E Rating ACCUMULATE ACCUMULATE Target Price 1,220 1,250 Sales (Rs. m) 77,051 90,755 78,649 92,117 % Chng. (2.0) (1.5) EBITDA (Rs. m) 13,031 15,744 13,849 16,075 % Chng. (5.9) (2.1) EPS (Rs.) % Chng. (3.4) (1.9) Key Financials FY17 FY18 FY19E FY20E Sales (Rs. m) 60,763 65,460 77,051 90,755 EBITDA (Rs. m) 9,689 10,594 13,031 15,744 Margin (%) PAT (Rs. m) 7,916 8,344 10,247 11,901 EPS (Rs.) Gr. (%) DPS (Rs.) Yield (%) RoE (%) RoCE (%) EV/Sales (x) EV/EBITDA (x) PE (x) P/BV (x) Key Data MBFL.BO MPHL IN 52-W High / Low Rs.1,279 / Rs.641 Sensex / Nifty 34,316 / 10,304 Market Cap Rs.206bn/ $ 2,811m Shares Outstanding 193m 3M Avg. Daily Value Rs m Shareholding Pattern (%) Promoter s Foreign Domestic Institution 8.71 Public & Others 9.88 Promoter Pledge (Rs bn) - Stock Performance (%) 1M 6M 12M Absolute (12.8) Relative (5.3) Madhu Babu madhubabu@plindia.com Rajat Gandhi rajatgandhi@plindia.com Modest Revenue and margin miss Softer performance in Digital Risk leads to revenue miss: Mphasis 2QFY19 results delivered a modest disappointment on USD revenues, margins and PAT. Revenues for the quarter came at USD275.5mn were up 2.5% QoQ and below our estimates (Ple: USD278mn). Constant currency growth stood at 3% QoQ. Revenues from Direct Channel Markets International (Ex Digital Risk) grew by 3.9% QoQ and 14.3% YoY in constant currency. Growth was driven by traction in Strategic accounts, new client wins and Blackstone portfolio. HP channel (28% of total revenues) grew by 6% QoQ and 23% YoY and remained strong. Digital Risk (11% of total revenues) remained soft for quarter with revenues at ~USD28mn for the quarter down ~10% YoY. Revenues from Emerging Markets (Predominantly India) which accounts to 4% of total revenues grew by 18% QoQ. Total Contract Value(TCV) of deal wins for the quarter remained strong at USD210mn for 2QFY19 (vs USD123mn in 2QFY18). This is the highest ever TCV win over the past few quarters. Management cited that 77% of the TCV wins are in new generation services. Mphasis cited that it is also seeing an Increase in average size of deals in the new deal wins. Company continues to focus on One Mphasis approach for driving cross selling of services across its clients. Hence, while Digital Risk is seeing softness mortgage origination business owing to rising interest rates, Mphasis is focusing on cross selling other services. Margins below estimates: Reported EBIDTA margin came at 17.4% down 30bps QoQ and below our estimates (Pl: 18.7%). Company had higher hedging losses (Rs330mn) for 2QFY19 and Mphasis takes hedge gain/(loss) in revenue line. Hence, reported EBIDTA margin was tepid for the quarter. Management cited that owing to unfavorable hedge position for FY19 (Hedges expiring in FY19 have an average rate of 67.5), it would not get any gain from the depreciating rupee ( as gains from translation would be negated by hedge losses).adjusted EBIDTA margin for the quarter came at 18.8% up 100bps QoQ. Management cited continued investments in supply chain and transition costs associated with new deals also weighed on margins for the quarter. EBIT margin for the quarter came at 16.5% down 10bps QoQ. Mphasis would have headwinds from wage hikes in 3QFY19. Company continues to maintain the stated EBIT margin guidance band of 15-17% for FY19. PAT came at Rs2718mn and below our estimates (Ple : Rs 2854mn). Emerging verticals drive growth: BFS (up 0.3% and 12% YoY), Insurance ( up 2.8% and down 0.2% YoY) and accounted to 46/11% of total revenues respectively. Mphasis derives 57% of total revenues from BFSI vertical and enjoys vertical specific competency in this vertical. For 2QFY19, Emerging vertical (which include Transportation, Logistics and Healthcare) have grown by 7.6% QoQ and accounted to 25.7% of total revenues. Mphasis management cited that it continues to focus on investing in emerging verticals to broaden its portfolio. Valuation and View: Led by 2Q revenue miss, we model Mphasis USD revenue to grow by 12.7/13.3% for FY19/FY20E (vs 13.8/13.3% modelled earlier). We expect HP channel /Direct Channel Mature markets revenues to grow by 22/11.5% YoY for FY19 and remain the growth drivers. However, Mphasis could fall behind other midcap peers on USD revenue growth for FY19. (LTI/Mindtree/NIIT Tech likely to deliver 18/18/17% organic USD revenue growth for FY19). We model Mphasis EBIT margin at 15.9/16.4% for FY19/FY20E (vs 15.1% in FY18). Our EPS estimates are modestly trimmed by 3.5/2//3% to Rs54/64/71.5/sh for FY19/FY20E/FY21E led by margin downgrade. Mphasis trades at 16.5x FY20 EPS (LTI/Mindtree/NIIT Tech trading at 18/15/15.7x). Lower TP by 3% to Rs 1220/sh (18x Sep 20E EPS vs 18x earlier) led by modest earnings cut. Retain Accumulate. Net cash on balance sheet stands at Rs23bn (Rs119/sh) which is 11% of Mcap. October 21,

2 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 (US$ mn) Mphasis Q1FY19: Consolidated P&L (Rs mn) Q2FY19 Q1FY19 QoQ Q2FY18 YoY Ple Var (Ple vs Actual) Consolidated Sales (USD mn) % % % Consolidated sales (Rs mn) 19, % 16, % 19, % EBITDA 3,338 3, % 2, % 3, % EBITDA Margins 17.4% 17.7% % % PAT 2,718 2, % 1, % 2, % HP channel delivers steady growth: Mphasis delivered a modest disappointment in 2QFY19 with USD revenues below our estimates. Revenues in 2QFY19 stood at USD 275.5Mn up 2.5% QoQ and below our estimates (Ple: USD 278Mn). HP channel (28% of total revenues) grew by 6% QoQ and 24% YoY. Mphasis also sees strong opportunities in HP channel across the four entities (HP Enterprises, DXC, Micro Focus, HP Inc.). Margin below estimates: Reported EBITDA Margins came at 17.4% and below our estimates (PLe: 17.7%). EBIT margin for the quarter stood at 16.5% down 10bps QoQ. PAT at Rs2718mn was 5% below our estimates (Rs2854mn) led by softer margins. Revenues by SBU (USD Mn) and growth (%) Fig in USD mn Q2FY19 Q1FY19 QoQ gr. Q2FY18 YoY gr. HP channel % % Direct Channel (Mature Markets) % % Direct Channel ( Emerging Markets) % % Total Revenues % % Mphasis Cons. USD Revenue (USD Mn) and revenue growth (YoY) Revenues YoY growth (%) (RHS) % % 15.0% 10.0% 5.0% 0.0% -5.0% % October 21,

3 1QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 (USD mn) Mphasis 6.0% 4.0% 2.0% 0.0% USD revenue growth QoQ (%) 2.8% 0.8% 1.0% 4.2% 4.9% 3.8% 5.0% 1.7% 2.5% -2.0% -0.3%-0.2%-0.3% -0.9% -1.6% -4.0% -6.0% -4.2% -5.4% 2QFY15 3QFY15 4QFY15 1QFY16-3.4% 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 HP Channel revenues (USD mn) and revenue growth QoQ (%) HP Channel revenues Growth (%) (RHS) % 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% Revenue growth to remain on strong footing: We expect Mphasis to show steady Revenue growth trajectory in FY19. HP channel and Direct Channel Mature Markets would remain the growth drivers for FY19. October 21,

4 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 Mphasis Consolidated Revenue Model of Mphasis Fig in USD mn FY15 FY16 FY17 FY18 FY19E FY20E FY21E HP channel Growth (%) (26.0) (11.3) % 19.4% 22.3% As a % of Total Revenues % 30.1% 28.5% Mature market - direct channel Growth (%) % 11.6% 11.6% As a % of Total Revenues % 56.8% 57.6% Emerging market - direct channel Growth (%) (27.0) (34.5) % 12.1% 6.5% As a % of Total Revenues % 3.6% 3.6% Digital Risk Growth (%) NA 22.2 (15.1) (11.4) -1.2% 4.2% -1.2% As a % of Total Revenues % 9.5% 10.3% Total Revenues Growth (%) (7.9) (1.9) (3.5) % 13.1% 12.7% TCV of deal wins for the quarter stood at USD210mn in 2QFY19 (vs USD123mn in 2QFY18). Higher Onsite revenues appear to be aiding revenue growth. For 2Q, revenues from onsite accounted to 58% of total revenues up 50bps QoQ and 270bps YoY. TCV wins of Mphasis (USD Mn) October 21,

5 We note that Mphasis reports forex hedge gains in the topline. Excluding the Hedge gains from topline, Adjusted EBIDTA margin for the quarter would be 18.7% up 100bps QoQ. Mphasis Adjusted EBIDTA margin stood at multi quarter high led by INR depreciation. Adjusted EBITDA Margin vs. Average rate (USD bs INR) 19.5% 18.5% 17.5% 16.5% 15.5% 14.5% 13.5% 16.9% 14.6% 14.6% 15.3% 14.3% 15.0% EBITDA 14.3% 15.5% 16.1% Average Rate 16.2% 15.5% 15.9% 14.9% 15.3% 16.5% 17.7% 17.7% 18.7% QFY15 2QFY15 3QFY15 4QFY15 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 Reported EBITDA Margin and Adjusted EBITDA Margin Reported EBIDTA margin Adjusted EBIDTA margin 20.0% 19.0% 18.0% 17.0% 16.0% 15.0% 14.0% 13.0% 14.3% 14.0% 15.0% 14.7% 14.3% 14.0% 15.5% 15.5% 16.1% 15.7% 16.2% 15.2% 15.5% 14.4% 15.9% 14.0% 14.9% 12.2% 15.3% 13.2% 16.5% 14.5% 17.7% 15.8% 17.7% 17.8% 17.4% 18.8% 12.0% 1QFY16 2QFY16 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 October 21,

6 Key Metrics: Revenue by Channels (%) Revenues by Channels (%) 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 HP channel Mature market - Direct channel Emerging market - direct channel Revenue by Verticals (%) Revenues by vertical (%) 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 Banking and Capital markets Insurance Information Technology, communication and entertainment Emerging Industries Revenue by Nature of Services (%) Revenue by Service Mix (%) 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 Application maintenance Application development Customer service Service/ Technical help desk Transaction processing service IMS Knowledge service License income Client Metrics 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 Clients contributing more than US$ 1 mn revenues Direct channel HP channel $ 5 mn revenues Direct channel HP channel $10 mn revenues Direct channel HP channel $20mn revenues Direct channel HP channel October 21,

7 Headcount Metrics 3QFY16 4QFY16 1QFY17 2QFY17 3QFY17 4QFY17 1QFY18 2QFY18 3QFY18 4QFY18 1QFY19 2QFY19 Onsite Applications 2,311 2,322 2,340 2, ITO BPO 1,564 1,359 1,236 1, Offshore Applications 8,423 8,441 8,495 8, ITO 3,730 3,209 3,158 3, BPO 6,019 5,511 5,682 5, Sales and marketing General and admin Total Headcount 23,512 22,302 22,358 22, Net addition (612) (1,210) 56 (67) (257) (40) (97) (31) October 21,

8 Consolidated Model Sheet of Mphasis FY14 FY15 FY16 FY17 FY18 FY19E FY20E FY21E Total Revenues( USD mn) Growth/(Decline) YoY 0% -8% -2% -3% 10.6% 12.7% 13.1% 13.6% Average Exchange Rate(USD vs INR) Revenues ( Rs mn) 62,254 57,948 60,879 60,763 65,460 77,051 90, ,281 Growth YoY(%) 7.4% -6.9% 5.1% -0.2% 7.7% 17.7% 17.8% 10.5% EBIDTA 10,553 8,700 8,970 9,689 10,594 13,031 15,744 17,471 PAT 7,418 6,778 7,242 8,068 8,475 10,247 11,901 13,275 EBIDTA margin(%) 17.0% 15.0% 14.7% 15.9% 16.2% 16.9% 17.3% 17.4% EBIT margin(%) 15.0% 13.3% 13.5% 14.6% 15.1% 16.0% 16.5% 16.6% PAT Margin(%) 11.9% 11.7% 11.9% 13.3% 12.9% 13.3% 13.1% 13.2% ROE(%) 14.8% 12.8% 12.3% 13.4% 14.6% 19.5% 22.3% 22.2% Dividend Payout ratio 46.0% 49.9% 0.0% 95.0% 45.0% 40.0% 40.0% 40.0% EPS EPS Growth(%) -2.3% -7.1% 7.2% 11.0% 13.7% 24.5% 18.4% 11.5% P/E P/S EV/EBIDTA Consolidated Balance sheet (Rs mn) Net cash on Balance sheet 18,424 23,296 22,831 26,244 17,820 12,343 17,295 22,803 Net cash per share on Balance sheet Net cash as % of Stock price 7.6% 9.6% 9.4% 10.8% 8.0% 6.3% 8.8% 11.6% Consolidated Cash Flow (Rs mn) Cash flow from operations ,330 9,180 10,618 11,636 Capex+Acqusitions (327) (800) (800) (800) Free Cash flow ,657 9,980 11,418 12,436 October 21,

9 Financials Income Statement (Rs m) Y/e Mar FY17 FY18 FY19E FY20E Net Revenues 60,763 65,460 77,051 90,755 YoY gr. (%) (0.2) Employee Cost 43,649 47,308 55,398 64,667 Gross Profit 17,114 18,152 21,654 26,088 Margin (%) SG&A Expenses 3,347 3,334 3,753 4,538 Other Expenses EBITDA 9,689 10,594 13,031 15,744 YoY gr. (%) Margin (%) Depreciation and Amortization Balance Sheet Abstract (Rs m) Y/e Mar FY17 FY18 FY19E FY20E Non-Current Assets Gross Block 4,105 4,304 5,104 5,904 Tangibles 1,890 2,050 2,850 3,650 Intangibles 2,215 2,254 2,254 2,254 Acc: Dep / Amortization 1,872 2,478 3,199 3,981 Tangibles 850 1,175 1,604 2,069 Intangibles 1,022 1,304 1,595 1,911 Net fixed assets 2,233 1,826 1,905 1,923 Tangibles 1, ,246 1,580 Intangibles 1, EBIT 8,898 9,885 12,311 14,962 Margin (%) Net Interest Other Income 2,385 1,620 1,416 1,200 Capital Work In Progress Goodwill 14,069 17,015 17,015 17,015 Non-Current Investments 2,508 4,397 4,826 5,226 Net Deferred tax assets 3,369 1,007 1,007 1,007 Other Non-Current Assets 6,331 6,077 6,177 6,277 Profit Before Tax 11,144 11,375 13,619 16,082 Margin (%) Total Tax 3,076 2,900 3,372 4,181 Effective tax rate (%) Profit after tax 8,068 8,475 10,247 11,901 Minority interest Share Profit from Associate Adjusted PAT 7,916 8,344 10,247 11,901 YoY gr. (%) Margin (%) Extra Ord. Income / (Exp) Reported PAT 7,916 8,344 10,247 11,901 YoY gr. (%) Margin (%) Other Comprehensive Income Total Comprehensive Income 7,916 8,344 10,247 11,901 Equity Shares O/s (m) EPS (Rs) Source: Company Data, PL Research Current Assets Investments 22,701 14,651 9,651 9,651 Inventories Trade receivables 6,279 8,116 7,839 7,824 Cash & Bank Balance 6,144 7,067 6,590 11,542 Other Current Assets 2,695 2,800 3,000 3,200 Total Assets 73,171 69,853 65,408 71,563 Equity Equity Share Capital 2,104 1,933 1,860 1,860 Other Equity 59,419 52,885 48,383 54,548 Total Networth 61,523 54,818 50,243 56,407 Non-Current Liabilities Long Term borrowings Provisions Other non current liabilities Current Liabilities ST Debt / Current of LT Debt 2,602 3,899 3,899 3,899 Trade payables 3,878 5,024 5,004 4,994 Other current liabilities 4,406 5,097 5,197 5,147 Total Equity & Liabilities 73,170 69,853 65,408 71,563 Source: Company Data, PL Research October 21,

10 Cash Flow (Rs m) Y/e Mar FY17 FY18 FY19E FY20E Key Financial Metrics Year Y/e Mar FY17 FY18 FY19E FY20E PBT 11,144 11,407 13,619 16,082 Per Share(Rs) Add. Depreciation 1,291 1, EPS Add. Interest CEPS Less Financial Other Income 2,385 1,620 1,416 1,200 BVPS Add. Other (1,962) (1,153) (1,323) (1,200) FCF Op. profit before WC changes 10,603 11,615 13,124 15,744 DPS Net Changes-WC (1,045) (1,502) (572) (945) Return Ratio(%) Direct tax (2,917) (2,783) (3,372) (4,181) RoCE Net cash from Op. activities 6,641 7,330 9,180 10,618 ROIC Capital expenditures (1,150) (313) (800) (800) RoE Interest / Dividend Income ,323 1,200 Balance Sheet Others 3,056 5,039 4,700 (300) Net Debt : Equity (x) (0.4) (0.3) (0.2) (0.3) Net Cash from Invt. activities 2,679 4,925 5, Debtor (Days) Issue of share cap. / premium 3 (11,032) (9,885) - Valuation(x) Debt changes (1,976) 1, PER Dividend paid (5,055) (3,949) (4,939) (5,736) P/B Interest paid (71) (98) (108) (80) P/CEPS Others EV/EBITDA Net cash from Fin. activities (7,100) (13,797) (14,882) (5,766) EV/Sales Net change in cash 2,220 (1,543) (479) 4,952 Dividend Yield (%) Free Cash Flow 5,460 7,002 8,380 9,818 Source: Company Data, PL Research Source: Company Data, PL Research Quarterly Financials (Rs m) Y/e Mar Q3FY18 Q4FY18 Q1FY19 Q2FY19 Net Revenue 16,607 17,445 18,202 19,149 YoY gr. (%) Raw Material Expenses 12,028 12,479 12,945 13,770 Gross Profit 4,579 4,966 5,257 5,379 Margin (%) EBITDA 2,741 3,096 3,221 3,338 YoY gr. (%) Margin (%) Depreciation / Depletion EBIT 2,565 2,925 3,042 3,154 Margin (%) Net Interest Other Income Profit before Tax 2,877 3,335 3,424 3,595 Margin (%) Total Tax Effective tax rate (%) Profit after Tax 2,136 2,539 2,578 2,718 Minority interest Share Profit from Associates Adjusted PAT 2,136 2,539 2,578 2,718 YoY gr. (%) Margin (%) Extra Ord. Income / (Exp) Reported PAT 2,136 2,539 2,578 2,718 YoY gr. (%) Margin (%) Other Comprehensive Income Total Comprehensive Income 2,136 2,539 2,578 2,718 Avg. Shares O/s (m) EPS (Rs) Source: Company Data, PL Research October 21,

11 Price Chart Recommendation History (Rs) Oct-15 Apr-16 Oct-16 Apr-17 Oct-17 Apr-18 Oct-18 No. Date Rating TP (Rs.) Share Price (Rs.) 1 27-Oct-17 Accumulate Jan-18 Accumulate Jan-18 Accumulate Apr-18 Accumulate May-18 Accumulate 1, Jul-18 Accumulate 1,150 1, Aug-18 Accumulate 1,250 1, Oct-18 Accumulate 1,250 1,148 Analyst Coverage Universe Sr. No. CompanyName Rating TP (Rs) Share Price (Rs) 1 Cyient BUY HCL Technologies BUY 1,255 1,077 3 Hexaware Technologies Hold Infosys BUY L&T Technology Services Accumulate 1,780 1,651 6 Mindtree BUY 1, Mphasis Accumulate 1,250 1,148 8 NIIT Technologies BUY 1,460 1,192 9 Redington (India) BUY Sonata Software BUY Tata Consultancy Services Accumulate 2,300 1, TeamLease Services Hold 2,740 2, Tech Mahindra BUY Wipro Hold Zensar Technologies BUY PL s Recommendation Nomenclature (Absolute Performance) Buy : > 15% Accumulate : 5% to 15% Hold : +5% to -5% Reduce : -5% to -15% Sell : < -15% Not Rated (NR) : No specific call on the stock Under Review (UR) : Rating likely to change shortly October 21,

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