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Mphasis: Strong performance

Apr 9, 2003

At the first glance it appears that Mphasis has posted a staid performance for the quarter ended March 2003 (4QFY03). The company’s topline has grown by 4% (QoQ), while bottomline has increased by 3%. While the numbers do no look impressive at the first glance, the company’s performance could have been affected by the geo-political developments in the past few months. For the full year FY03, the company has posted 33% increase in revenues, while the net profits have jumped by 64% on the back of improvement in operating margins. The steep rise comes inspite of a significant decline in other income.

Rs m) 3QFY03 4QFY03 Change FY02 FY03 Change
Net Sales 1,159 1,209 4.3% 3,133 4,293 37.0%
Other Income (8) 18 -339.3% 50 12 -76.8%
Expenditure 938 1,010 7.7% 2,790 3,539 26.9%
Operating Profit (EBDIT) 221 199 -10.1% 344 753 119.0%
Operating Profit Margin (%)@ 19.1% 16.4%   11.0% 17.5%  
Interest (2) (5) 124.1% (25) (23) -11.0%
Depreciation - -   - -  
Profit before Tax 216 222 2.9% 419 788 87.8%
Extraordinary items - -   - -  
Tax 34 35 2.5% 10 118 1090.2%
Profit after Tax/(Loss) 182 187 2.9% 409 669 63.5%
Net profit margin (%) 15.7% 15.5%   13.1% 15.6%  
No. of Shares 17.3 17.3   17.3 17.3  
Diluted Earnings per share* 42.1 43.3   23.7 38.7  
P/E Ratio   15.0     16.8  
(* annualised)            
@ includes depreciation            

Highlight of the performance for the fiscal FY03 has been on two fronts. First is the swift growth in revenues of its ITES (IT enabled services) subsidiary, MsourcE. MsourcE largely spearheaded the 37% growth in topline in FY03. The IT services business has grown by 16% in FY03. This is however, much lower than the industry growth rate, which is expected to be around 22%. In 4QFY03, revenue growth from the services business was flat.

Revenues (Rs m) 3QFY03 4QFY03 Change FY02 FY03 Change
Mphasis 897 904 0.7% 2,898 3,356 15.8%
% contribution 77.4% 74.8%   92.5% 78.2%  
MsourcE 262 305 16.5% 236 937 297.6%
% contribution 22.6% 25.2%   7.5% 21.8%  
Total 1,159 1,209 4.3% 3,133 4,293 37.0%

Another positive aspect of the performance for FY03 is the improvement in operating margins -from 13.7% in FY02 to 22.7% in FY03. This has been possible due to a slower growth in selling expenses as compared to the growth in revenues. Further, the company has managed to reduce administrative expenses by 7% in FY03.

Operating margins* FY02 1QFY03 2QFY03 3QFY03 4QFY03 FY03
Mphasis 13.7% 18.4% 21.0% 24.3% 25.5% 22.7%
MsourcE -22.2% 6.0% 9.7% -3.0% -10.4% -1.0%
Consolidated 11.0% 15.4% 18.9% 19.1% 16.4% 17.5%
*includes depreciation            

In 4QFY03, the company added six new clients. Of this, one was an MsourcE client. The total number of active clients for MsourcE at the end of the fiscal was 17. However, client concentration continued to be a cause for concern. The top client accounted for 19% of Mphasis’ revenues and the billing from top ten clients accounted for 51% services revenues.

The billing rates for 4QFY03 remained unchanged when compared on a sequential basis. However for FY03, Mphasis saw a 7% improvement in its onsite realisations. This quite an achievement considering the fact that the business environment continues to be challenging and its peers are facing intense pricing pressure. The average billing rates for MsourcE have also increased by 9% in FY03. Going forward, while the company is likely to find it difficult to negotiate hikes in billing rates, higher growth in volumes could compensate for a decline or stagnation in billing rates.

The onsite-offshore mix changed in favour of onsite projects. In FY03, Mphasis saw revenues from the onsite business growing by 26%. Consequently, the share of revenues from onsite projects went up to 62% in FY03 from 57% in FY02. This could be due to the higher growth in service offerings that require onsite presence. While there was growth in revenues from software development, maintenance and testing (usually done offshore), the development of e-solutions for customer’s onsite seems to have been higher.

While for the fourth quarter the growth in revenues largely stemmed from the technology vertical, for the full year the growth in topline came from the financial services vertical. In 4QFY03, the company saw a sequential decline in revenues from the financial services vertical. This is a cause for concern, as the company derives 53% of its revenues from the financial services vertical. Retail, logistics and transportation verticals contribute 28%. The remaining 19% comes from the technology vertical.

As far as the geographical break-up of revenues is concerned, Mphasis saw significant growth in revenues from the US. However, Europe and Asia Pacific geographies witnessed a slowdown in revenues. This decline in revenues from Europe is likely due to major economies in the region like Germany showing signs of a slowdown.

(Rs m) FY02 FY03 Change
US 1,845 63.6% 2,271 67.6% 23.1%
Europe 417 14.4% 359 10.7% -13.9%
Asia Pacific 251 8.7% 169 5.0% -32.7%
Japan 186 6.4% 352 10.5% 89.2%
India & Middle East 200 6.9% 209 6.2% 4.5%
Total 2,899 100.0% 3,360 100.0%  

At the current market price of Rs 651, the stock is trading at a P/E multiple of 12x its FY04 estimated earnings. The management expects the revenues from the ITES services business to grow by 100% in FY04. Our earnings estimates factor in a lower growth in the business. Key to the growth in earnings is the improvement in operating margins. While Mphasis’ services margins have been steadily improving, MsourceE has been in the red for the past two quarters at the operating levels. Our expectations of a strong growth in earnings for FY04 factor in MsourcE’s margins becoming positive at an operating level. Considering the strong growth prospects of the ITES industry and the fact that services business is also likely to improve going forward, the valuations look attractive. However, considering the uncertainty in the external environment, the element of risk is on the higher side.

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