Increased confidence on margins July 25, 2016 Govind Agarwal govindagarwal@plindia.com +91 22 66322300 Rating BUY Price Rs540 Target Price Rs570 Implied Upside 5.6% Sensex 28,095 Nifty 8,636 (Prices as on July 25, 2016) Trading data Market Cap. (Rs bn) 113.4 Shares o/s (m) 209.9 3M Avg. Daily value (Rs m) 104.3 Major shareholders Promoters 60.48% Foreign 20.41% Domestic Inst. 8.33% Public & Other 10.78% Stock Performance (%) 1M 6M 12M Absolute (1.7) 18.7 29.9 Relative (8.1) 4.0 29.9 How we differ from Consensus EPS (Rs) PL Cons. % Diff. 2017 36.9 38.4 4.1 2018 40.4 42.9 5.7 Price Performance (RIC:MBFL.BO, BB:MPHL IN) (Rs) 700 600 500 400 300 200 100 0 Jul 15 Sep 15 Nov 15 Source: Bloomberg Jan 16 Mar 16 May 16 Jul 16 Mphasis Q1FY17 revenues and margins were largely in line with expectations. HP revenues declined ~4% QoQ; however, it is likely to stabilize in Q2/Q3. Direct International business had healthy deal wins of US$96m in Q1FY17 post US$303m worth deals in FY16. We believe with HP revenue stabilizing (post Blackstone deal) and steady outlook in non HP business, Mphasis is likely to reverse the trend of revenue decline witnessed in the past five years. We forecast 1%/6% YoY USD revenue growth in FY17/18 with ~110bps margin expansion over FY16 18. Clarity on revenue opportunity from Blackstone investee companies will emerge by H2FY17, which will provide upside to FY18 estimates. Q1FY17 USD EBIT growth of 15% YoY with margin expansion of 71/253bps QoQ/YoY is heartening in our view, given the margin pressure faced by most of its peers. Management has also outlined EBIT Margin range of 14 16% for FY17 (earlier for H1FY17) with QoQ margin expansion in Q2FY17. We retain BUY with TP of Rs570 based on 14x FY18 EPS. Overall in line results: Mphasis reported flat USD revenue growth at US$225.6m (PLe: $228.0m, Cons.: $226.0m). EBITDA grew by 2.7% QoQ and 16% YoY largely in line with expectations. EBITDA margins, however, increased by 41/198 QoQ/YoY, respectively, to 16.1% (PLe: 16.1%, Cons: 16%). Adjusted Net profit came slightly ahead of our estimates. Adj. EPS grew 6.4% QoQ to Rs9.7 (PLe: Rs9.4, Cons.: Rs9.2). HP business close to bottoming out: HP Channel declined 4.2% QoQ/22% YoY, though the QoQ decline was lower compared to last few quarters. Management indicated that HP business will stabilise by Q2FY17. Direct International revenues grew by 1.5% QoQ to US$162.8m, up 8% YoY and would be the company s key area of focus, going ahead. Healthy deal wins in Direct International channel: Deal wins continue to be healthy, with US$96m worth deals signed in Q1FY17 in Direct International channel (Q4FY16: US$76m). We believe the revenue contribution from the Direct International business will be able to offset the drop in HP revenues. Key financials (Y/e March) 2015 2016 2017E 2018E Revenues (Rs m) 57,803 60,740 62,752 66,786 Growth (%) (8.5) 5.1 3.3 6.4 EBITDA (Rs m) 8,555 8,831 9,525 10,433 PAT (Rs m) 6,746 7,159 7,746 8,495 EPS (Rs) 32.1 34.1 36.9 40.4 Growth (%) (7.2) 6.1 8.2 9.7 Net DPS (Rs) 16.0 24.2 25.4 Profitability & Valuation 2015 2016 2017E 2018E EBITDA margin (%) 14.8 14.5 15.2 15.6 RoE (%) 12.7 12.3 12.2 12.8 RoCE (%) 11.6 11.2 11.2 11.8 EV / sales (x) 2.0 1.8 1.7 1.6 EV / EBITDA (x) 13.5 12.4 11.2 10.1 PE (x) 16.8 15.9 14.7 13.4 P / BV (x) 2.1 1.8 1.8 1.7 Net dividend yield (%) 3.0 4.5 4.7 Source: Company Data; PL Research Q1FY17 Result Update Prabhudas Lilladher Pvt. Ltd. and/or its associates (the 'Firm') does and/or seeks to do business with companies covered in its research reports. As a result investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of the report. Investors should consider this report as only a single factor in making their investment decision. Please refer to important disclosures and disclaimers at the end of the report
Exhibit 1: USD Revenue growth to turn positive Exhibit 2: USD EBIT growth YoY $ Revenue growth YoY $ EBIT growth YoY 8.0% 6.0% 4.0% 2.0% 2.0% 4.0% 6.4% 1.2% 1.9% FY16 FY17E FY18E 12.0% 1 8.0% 6.0% 4.0% 2.0% 2.0% 9.8% 6.0% 0.4% FY16 FY17E FY18E Exhibit 3: USD Revenue growth YoY on quarterly basis US $ Revenue growth (YoY) 1 8.0% 6.0% 4.0% 2.0% 2.0% 4.0% 6.0% 8.0% 1 7.8% 6.0% 1.0% 1.1% 1.9% 3.9% 3.5% 7.4% 7.6% 6.5% 6.0% 5.7% Exhibit 4: USD EBIT growth YoY on quarterly basis $ EBIT growth YoY 3 2 1 6.6% 2.1% 22.0% 15.2% 1.0% 8.2% 7.5% 10.3% 9.9% 11.7% 1 2.6% 2 3 21.4% July 25, 2016 2
Exhibit 5: Q1FY17: Revenues and margins largely in line with expectations Q1FY17 Q4FY16 QoQ Q1FY16 YoY Cons PLe Variance Consolidated Sales (USD m) 225.6 225.0 0.3% 235 3.9% 226 228 0.8% Consolidated Sales (Rs m) 15,167 15,160 14,945 1.5% 15,285 15,218 0.3% EBITDA (Rs m) 2,445 2,381 2.7% 2,113 15.7% 2,449 2,447 0.1% EBITDA Margin 16.1% 15.7% 14.1% 198 16.0% 16.1% PBT (Rs m) 2,827 2,643 7.0% 2,269 24.6% 2,702 2,738 3.3% Tax (Rs m) 784 723 8.4% 611 28.3% 761 753 4.1% Tax Rate 27.7% 27.4% 38 26.9% 80 28.2% 27.5% 23 PAT (Rs m) 2,043 1,920 6.4% 1,658 23.2% 1,941 1,985 2.9% EPS (Rs) 9.7 9.1 6.4% 7.9 23.2% 9.2 9.4 3.1% Exhibit 6: USD revenue decline YoY 2.0% 2.0% 4.0% 6.0% 8.0% 1 12.0% 14.0% US $ Revenue growth (YoY) 1.1% 1.0% 1.4% 3.9% 5.8% 6.0% 7.8% 11.2% 11.5% Q1FY15 Q2FY15 Q3FY15 Q4FY15 Exhibit 7: Double digit USD EBIT Growth YoY $ EBIT growth YoY 3 2 1 1 6.6% 2.1% 22.0% 15.2% 2 3 21.4% July 25, 2016 3
Exhibit 8: Company has delivered on EBIT margin guidance given last quarter (14 16%) EBIT Margins 16.0% 15.0% 15.2% 14.5% 15.2% 14.0% 13.0% 12.6% 12.8% 11.7% 12.7% 13.6% 12.9% 12.0% 11.0% 1 Q1FY15 Q2FY15 Q3FY15 Q4FY15. Exhibit 9: Highest TCV in the last five quarters TCV (US$ mn) 120 100 80 60 76 90 61 76 96 40 20 0. Exhibit 10: Revenues from HP on a declining trend, however, revenues to stabilise Q2FY17 onwards HP revenue (US$mn) 250 200 150 183 188 191 170 158 159 138 134 122 120 100 109 103 95 93 90 86 78 71 67 63 55 55 52 50 July 25, 2016 4
Exhibit 11: Direct International revenue on a growing trend Direct International (US$ mn) 170.0 160.0 150.0 140.0 130.0 143.4 140.0 129.5 139.2 150.3 157.6 161.2 160.4 162.8 120.0 110.0 100.0 Q1FY15 Q2FY15 Q3FY15 Q4FY15. Exhibit 12: Revenue decline in ICE and Insurance Revenue (US$ m) Q1FY17 Q4FY16 QoQ Q1FY16 YoY Banking and Capital Market 109.7 108.9 0.8% 103.9 5.6% Insurance 34.2 36.3 5.8% 36.2 5.5% Information, Comm. & Ent. (ICE) 23.0 24.1 4.7% 33.6 31.5% Emerging Industries 57.6 55.8 3.2% 60.6 4.9% % of Total Banking and Capital Market 48.6% 48.4% 24 bps 44.2% 441 bps Insurance 15.1% 16.1% 98 bps 15.4% 26 bps Information, Comm. & Ent. (ICE) 10.2% 10.7% 54 bps 14.3% 410 bps Emerging Industries 25.5% 24.8% 73 bps 25.8% 25 bps Exhibit 13: Revenue decline across segments except Direct International By Secondary Market (US$ m) Q1FY17 Q4FY16 QoQ Q1FY16 YoY HP Channel 52.5 54.8 4.2% 67.4 22.2% Direct International 162.8 160.4 1.5% 150.3 8.3% Others 9.2 10.1 8.5% 16.7 45.0% Exhibit 14: BPO realizations improve YoY aided by divestiture of India BPO Price Movement(USD/hr) Q1FY17 Q4FY16 QoQ Q1FY16 YoY Onsite Applications 76 76 71 7.0% Onsite ITO 68 67 1.5% 62 9.7% Offshore Applications 21 22 4.5% 21 Offshore BPO 10 10 6 66.7% Offshore ITO 19 18 5.6% 20 5.0% July 25, 2016 5
Exhibit 15: Decline in >US$5m client bucket Customer Size Distribution Q1FY17 Q4FY16 QoQ Q1FY16 YoY >1m 102 103 1.0% 98 4.1% >5m 28 35 2 36 22.2% >10m 15 14 7.1% 20 25.0% >20m 9 8 12.5% 8 12.5% Exhibit 16: Headcount decline in Offshore ITO and Onsite BPO People Management Q1FY17 Q4FY16 QoQ Q1FY16 YoY Onsite Applications 2,340 2,322 0.8% 2,366 1.1% Onsite BPO 1,236 1,359 9.1% 1,646 24.9% Onsite ITO 215 212 1.4% 169 27.2% Offshore Applications 8,495 8,441 0.6% 8,261 2.8% Offshore BPO 5,682 5,511 3.1% 16,093 64.7% Offshore ITO 3,158 3,209 42.7% 4,244 25.6% Total Headcount Onsite 3,791 3,893 2.6% 4,181 9.3% Total Headcount Offshore 17,335 17,161 1.0% 28,598 39.4% Sales and Marketing 289 300 3.7% 316 8.5% General and Administration 943 948 0.5% 1,041 9.4% Overall Headcount 22,358 22,302 0.3% 34,136 34.5% Utilization (excluding Trainees) Blended Application 85.0% 84.0% 100 bps 88.0% 300 bps BPO 94.0% 89.0% 500 bps 78.0% 1600 bps ITO 94.0% 91.0% 300 bps 94.0% 0 bps Exhibit 17: India was the exception with QoQ revenue decline Geo Spread Q1FY17 Q4FY16 QoQ Q1FY16 YoY Americas 173.9 172.9 0.6% 173.4 0.3% EMEA 24.2 24.1 0.5% 23.1 4.6% India 14.6 15.0 3.0% 22.9 36.4% RoW 13.0 13.0 0.1% 15.4 15.6% Total 226 225 0.3% 235 3.9% % of Total America 77.1% 76.9% 21 bps 73.8% 323 bps Europe 10.7% 10.7% 2 bps 9.9% 88 bps India 6.5% 6.7% 22 bps 9.8% 330 bps RoW 5.8% 5.8% 1 bps 6.6% 80 bps Total 10 10 0 bps 10 0 bps July 25, 2016 6
Exhibit 18: Growth in AMS. ADM, Customer service and Technical helpdesk decline sharply Practices Q1FY17 Q4FY16 QoQ Q1FY16 YoY Application Maintenance & Services 80.4 76.8 4.7% 68.3 17.8% Application Development 52.0 55.1 5.6% 58.1 10.5% Costumer Service 4.2 4.6 8.2% 12.4 66.4% Service/Technical Help Desk 4.7 5.1 8.4% 4.6 2.4% Transaction Processing Services 15.7 16.0 2.1% 15.3 2.4% Infrastructure Management Services 30.6 30.5 0.3% 35.0 12.6% Knowledge Process + Licenses 36.9 36.9 40.4 8.7% % of revenue Application Maintenance & Services 35.6% 34.1% 149 bps 29.1% 657 bps Application Development 23.0% 24.5% 145 bps 24.7% 169 bps Costumer Service 1.9% 2.0% 17 bps 5.3% 345 bps Service/Technical Help Desk 2.1% 2.3% 20 bps 2.0% 13 bps Transaction Processing Services 7.0% 7.1% 17 bps 6.5% 43 bps Infrastructure Management Services 13.6% 13.6% 1 bps 14.9% 135 bps Knowledge Process + Licenses 16.4% 16.4% 5 bps 17.2% 85 bps Exhibit 19: Client Metrics Q1FY17 Q4FY16 QoQ Q1FY16 YoY Customer Concentration Top Customer 24.8 24.7 0.3% 21.1 17.4% Top 5 88.0 85.5 2.9% 82.2 7.0% Top 2 5 63.2 60.7 4.0% 61.1 3.5% Top 6 10 56.4 54.0 4.5% 49.3 14.4% Top 10 119.6 114.7 4.2% 110.4 8.3% Non Top 10 customers 106.0 110.2 3.8% 124.5 14.8% Top Customer 11.0% 11.0% 0 bps 9.0% 200 bps Top 5 39.0% 38.0% 100 bps 35.0% 400 bps Top 10 53.0% 51.0% 200 bps 47.0% 600 bps Non Top 10 customers 47.0% 49.0% 200 bps 53.0% 600 bps July 25, 2016 7
Exhibit 20: Decline in revenue from Fixed Price Projects (FPP) Service Delivery Q1FY17 Q4FY16 QoQ Q1FY16 YoY Revenue from T&M 179.9 177.8 1.2% 205.7 12.5% Revenue from FPP 45.7 47.1 3.1% 29.2 56.6% Onsite Revenue 115.3 115.7 0.4% 115.8 0.4% Offshore Revenue 110.3 109.2 1.0% 119.0 7.3% % of Total Revenue from T&M 79.7% 79.0% 70 bps 87.6% 783 bps Revenue from FPP 20.3% 21.0% 70 bps 12.4% 783 bps Onsite Revenue 51.1% 51.5% 34 bps 49.3% 180 bps Offshore Revenue 48.9% 48.5% 34 bps 50.7% 180 bps Exhibit 21: USD revenue growth trend Exhibit 22: INR Revenue movement over the last few quarters Revenue (US$ m) (LHS) QoQ Gr. YoY Gr. Revenue (Rs m) (LHS) QoQ Gr. YoY Gr. 240 235 230 225 220 215 4% 2% 0% 2% 4% 6% 8% 15600 15400 15200 15000 14800 14600 10% 8% 6% 4% 2% 0% 2% 4% Source: PL Research, Company Data Source: PL Research, Company Data Exhibit 23: EBITDA growth and margin trend Exhibit 24: PAT growth trend over the course of last few quarters 17% 16% EBITDA Margin (LHS) EBITDA gr. YoY EBITDA gr. QoQ 30% 20% 3 2 QoQ YoY 15% 10% 1 14% 13% 12% 0% 10% 20% 1 2 July 25, 2016 8
Income Statement (Rs m) Y/e March 2015 2016 2017E 2018E Net Revenue 57,803 60,740 62,752 66,786 Raw Material Expenses 43,424 45,175 45,503 48,243 Gross Profit 14,379 15,565 17,250 18,543 Employee Cost Other Expenses 5,824 6,734 7,724 8,109 EBITDA 8,555 8,831 9,525 10,433 Depr. & Amortization 980 744 769 818 Net Interest Other Income 1,833 1,737 1,928 2,102 Profit before Tax 9,408 9,824 10,685 11,717 Total Tax 2,630 2,665 2,938 3,222 Profit after Tax 6,778 7,159 7,746 8,495 Ex Od items / Min. Int. 32 Adj. PAT 6,746 7,159 7,746 8,495 Avg. Shares O/S (m) 210.1 210.2 210.2 210.2 EPS (Rs.) 32.1 34.1 36.9 40.4 Cash Flow Abstract (Rs m) Y/e March 2015 2016 2017E 2018E C/F from Operations 5,954 7,040 9,420 8,375 C/F from Investing (3,816) (1,207) (1,351) (1,514) C/F from Financing (1,998) (5,081) (5,336) Inc. / Dec. in Cash 141 5,833 2,987 1,526 Opening Cash 3,532 4,035 9,868 12,855 Closing Cash 4,035 9,868 12,855 14,381 FCFF 7,584 6,588 8,068 6,862 FCFE 7,941 6,588 8,068 6,862 Key Financial Metrics Y/e March 2015 2016 2017E 2018E Growth Revenue (%) (8.5) 5.1 3.3 6.4 EBITDA (%) (25.5) 3.2 7.9 9.5 PAT (%) (7.1) 6.1 8.2 9.7 EPS (%) (7.2) 6.1 8.2 9.7 Profitability EBITDA Margin (%) 14.8 14.5 15.2 15.6 PAT Margin (%) 11.7 11.8 12.3 12.7 RoCE (%) 11.6 11.2 11.2 11.8 RoE (%) 12.7 12.3 12.2 12.8 Balance Sheet Net Debt : Equity (0.1) (0.1) (0.1) Net Wrkng Cap. (days) Valuation PER (x) 16.8 15.9 14.7 13.4 P / B (x) 2.1 1.8 1.8 1.7 EV / EBITDA (x) 13.5 12.4 11.2 10.1 EV / Sales (x) 2.0 1.8 1.7 1.6 Earnings Quality Eff. Tax Rate 28.0 27.1 27.5 27.5 Other Inc / PBT 19.5 17.7 18.0 17.9 Eff. Depr. Rate (%) 9.0 6.6 6.1 5.8 FCFE / PAT 117.7 92.0 104.2 80.8. Balance Sheet Abstract (Rs m) Y/e March 2015 2016 2017E 2018E Shareholder's Funds 54,798 61,958 64,623 67,782 Total Debt 5,753 5,753 5,753 5,753 Other Liabilities 500 500 500 500 Total Liabilities 61,051 68,211 70,876 74,035 Net Fixed Assets 1,874 2,337 2,919 3,615 Goodwill 21,781 21,781 21,781 21,781 Investments 23,606 23,606 23,606 23,606 Net Current Assets 12,964 19,763 21,845 24,309 Cash & Equivalents 4,034 9,868 12,855 14,381 Other Current Assets 21,805 23,258 22,796 24,621 Current Liabilities 12,875 13,363 13,805 14,693 Other Assets 826 826 826 826 Total Assets 61,051 68,313 70,978 74,137 Quarterly Financials (Rs m) Y/e March Q2FY16 Q3FY16 Q4FY16 Q1FY17 Net Revenue 15,519 15,122 15,160 15,167 EBITDA 2,289 2,121 2,381 2,445 % of revenue 14.7 14.0 15.7 16.1 Depr. & Amortization 179 167 181 137 Net Interest Other Income 473 448 443 519 Profit before Tax 2,583 2,402 2,643 2,827 Total Tax 683 666 723 784 Profit after Tax 1,847 1,736 1,604 2,043 Adj. PAT 1,900 1,736 1,604 2,043 Key Operating Metrics Y/e March 2015 2016 2017E 2018E Revenue (US$ m) 944 926 937 997. July 25, 2016 9
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