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Mphasis: Rupee takes toll

Aug 8, 2007

Performance summary
  • Topline grows 6% QoQ aided by growth in volumes and billing rates. Merger with EDS completed during the quarter.

  • Operating expenses grow 5% QoQ mainly due to salary hike given to 60% of employees; operating margins expands marginally by 40 basis points.

  • PAT margins contract by 3% largely due to negative other income and higher depreciation.

Consolidated financial performance: A snapshot…
(Rs m) 4QFY07 1QFY08 Change
Sales 5,040 5,316 5.5%
Expenditure 4,132 4,338 5.0%
Operating Profit 909 977 7.6%
Operating Profit margin (%) 18.0% 18.4%  
Other income (7) (147)  
Depreciation 239 305 27.6%
Profit before tax 663 526 -20.6%
Tax 34 13 -62.4%
Profit after tax/(loss) 629 513 -18.4%
Net profit margin (%) 12.5% 9.7%  
No. of shares (m) 165.1 210.3  
Diluted earnings per share (Rs)*   6.6  
P/E ratio (x)*   42.9  
*on a trailing 12 months basis

What is company’s business?
Mphasis is a mid-sized player in the Indian software sector. However, despite its small size, the company has carved a niche due to its broad range of quality offerings, particularly in the BFSI segment. The company has a special focus on the BPO segment, which contributes to 30% of the total revenues. FY07 was a relatively subdued year for the company but with EDS acquiring the company, things are expected to be better going forward.

What has driven performance in 1QFY08?
Volume growth drives business: Mphasis consolidated revenues grew 6% QoQ mainly due to increase in existing business volumes coupled with addition of new clients during the quarter. Revenues from applications grew by 8% QoQ with the financial services vertical contributing 43% of the total revenues. BPO revenues dropped marginally by 0.2% QoQ due to appreciation in rupee against the dollar. In line with the topline growth, IT outsourcing (ITO) services revenues grew 6% QoQ but the overall revenue growth during the quarter has been impacted by the strengthening of the rupee against the US dollar. As regards service offerings, the growth has more or less been stable. Onsite billing rates increased by US$ 1 per hour and the offshore billing rates for ITO also increased by US$ 1 per hour. Currently, around 5% of the revenues come from in-house EDS work and going forward though the figure in absolute dollar terms will increase, the share of revenues from in-house work will come down.

Mphasis added a net of 2,058 employees during 1QFY08, with 908 added in applications, 556 in BPO and 594 in ITO Services, taking the total manpower to 22,070 in 1QFY08. On the client front, the company added 25 new clients during the quarter and the total number of active clients now stands at 124. On a blended basis, the utilisation levels have remained stable.

Segmental Information
(Rs m) 4QFY07 1QFY08 Change
Application revenues 3,231 3,475 7.6%
% of total revenues 64.1% 65.4%  
PBIT margin (%) 28.0% 26.6%  
BPO revenues 1,246 1,244 -0.2%
% of total revenues 24.7% 23.4%  
PBIT margin (%) 27.3% 26.1%  
IT outsourcing revenues 563 597 5.9%
% of total revenues 11.2% 11.2%  
PBIT margin (%) 15.9% 14.9%  

Lower selling and administrative expenses help operating margins: Mphasis’ cost of revenue increases by 7% QoQ, and represented 75% of total revenues in 1QFY08 (74% in 4QFY07). Selling expenses decreased from 5.3% of sales in 4QFY07 to 4.6% in 1QFY08. As a large part of selling expenses are incurred in foreign currencies, the strengthening of the rupee has resulted in a net lower cost in rupee terms. General and administrative expenses decreased marginally to 7.8% in 1QFY08 as against 7.9% in 4QFY07. Had the rupee wouldn’t have appreciated the operating profits would have been higher by Rs 330 m. Moreover, the BPO and ITO revenue are generated in offshore locations so there is no natural hedge and hence the impact is more severe over there.

Exchange losses hit bottomline: Mphasis’ profit after tax decreased by 18% QoQ and the net margin contracted from 12.5% in 4QFY07 to 9.7% in 1QFY07. Lower operating profits, higher foreign exchange losses have resulted in the decrease in net profits and net margins during the quarter. The loss on foreign exchange during the quarter was primarily on account of restatement of foreign currency denominated current assets consequent to the appreciation of the rupee against the dollar. But the bottomline was boosted by lower taxes. The effective rate of tax has come down from 5% in 4QFY07 to 2% in 1QFY08. Lower deferred tax asset reversal of foreign entities and recognition of deferred tax assets in Indian entities in the current quarter have resulted in a lower income tax charge as compared to the previous quarter.

Performance over the past quarters
1QFY07 2QFY07 3QFY07 4QFY07 1QFY08
Sales growth (%, QoQ) 4.1 12.0 4.8 10.2 5.5
Cost of sales (% of sales) 76.2 41.1 69.4 68.9 74.9
Selling expenses (% of sales) 7.6 8.1 7.1 7.9 4.6
G&A expenses (% of sales) 9.7 9.5 9.4 8.8 7.8
EBDIT margins (%) 12.1 9.5 12.5 19.0 18.4
Profits growth (%, QoQ) -56.9 35.0 53.0 27.3 -18.4
Employees (Nos.)* 11,234 12,535 12,719 14,679 22,070
*1QFY08 includes employees of EDS India

What to expect?
At the current price of Rs 283, the stock is trading at a multiple of 16.7 times our estimated FY09 earnings. The company is working in tandem with EDS clients and they are being billed on a cost plus basis. More importantly the company has succeeded to invoke the clause in the contract to charge their customers higher if the rupee goes beyond a particular level. This is a positive, as it shall reduce the effect of currency volatility in Mphasis’ financials. The BPO division, which currently contributes to 23% of revenues, is in a changeover mode to a transaction based service provider rather than a voice based service provider. Mphasis has had a volatile performance history but with EDS acquisition completed, things could shape up well for it going forward.

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