Mphasis: Headwinds receding, risk-reward balanced

7 Mar 2024 , 12:24 PM

Analysts of IIFL Capital Services upgrade Mphasis (MPHL) to ADD (from REDUCE) with a 12-month TP of Rs2,600; implying 3% upside. After a sharp underperformance in the past two years leading to ~30% cut in FY24/25 EPS from its peak, the discount to mid-cap peers has expanded to ~20%. Analysts of IIFL Capital Services believe MPHL’s headwinds around DXC, DR and large clients are largely behind and its growth should converge towards peers through CY24 (2.6% Cqgr vs 3.4% for peers). MPHL has invested in expanding capabilities, verticals and geos to increase the TAM; which is visible in Direct channel (ex-DR) and non-top 10 client revenue growth, new client acquisition and deal wins. Analysts of IIFL Capital Services expect the ramp-up of won deals to result in a pickup in revenue Cqgr and forecast 11%/15% USD revenue/EPS Cagr over FY24-26. A sharp reversal in interest rate cycle in US and rebound in BFSI could pose upside risk to analysts of IIFL Capital Services estimates. The stock is currently trading at 23x FY26 P/E, leaving limited room for further de-rating given the potential pickup in growth. Hence, analysts of IIFL Capital Services upgrade to ADD.

Key drags on revenue largely behind:

Analysts of IIFL Capital Services expect MPHL’s Direct business (95% of revenues) to grow at 12% Cagr over FY24-26, driven by continued ramp-up of previously won deals, growth in non-top 10 clients and new client acquisition. Mortgage business (~6% of revenues) has bottomed out and could pick up once the interest rates start coming down in US. DXC now contributes only ~3% of the revenues. MPHL has won deals of ~USD1.2bn TCV in M9FY24 in the Direct channel (incl. 14 large deals), which gives visibility for near-term growth as revenue leakage subsides.

Operating leverage to drive margins higher:

Over the last three years, MPHL’s Ebit margins have been in a tight range of 15-16%. Some of the mid-cap peers have managed to increase margins, driven by operating leverage and productivity improvements. Analysts of IIFL Capital Services expect MPHL’s margins to inch up to 16% over the medium term, as growth rebounds, operating leverage kicks in and impact of merger-related costs subside.

Risk-reward balanced; upgrade to ADD:

MPHL trades at 23x FY26 P/E, at a ~20% discount to mid-cap peers. Analysts of IIFL Capital Services believe as MPHL’s revenue growth differential vs mid-cap peers reduces, the discount would narrow. They raise FY25/FY26 EPS by up to 3% and 12-mth TP to ₹2,600, now pegged at 24x (was 20x). Key risks: FX, BFS tech spending.