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MphasiS: BPO focus paying off…

Oct 9, 2003

MphasiS has reported strong performance for the September quarter with the topline and bottomline growing by 10% and 31% respectively on a sequential basis. The performance on the half-yearly basis has also been good for MphasiS (YoY growth in topline has been 42% while the profits are up by around 50%). While the company has improved upon its operating margins for the quarter by about 200 basis points, for 1HFY04, margins are lower by 300 basis points.

Financial performance: A snapshot...
(Rs m) 1QFY04 2QFY04 Change 1HFY03 1HFY04 Change
Sales 1,302 1,429 9.8% 1,924 2,732 41.9%
Other Income 28 39 39.7% 1 67 -
Expenditure 1,127 1,210 7.4% 1,591 2,337 46.8%
Operating Profit (EBDIT)** 175 219 25.2% 333 395 18.5%
Operating Profit Margin (%) 13.5% 15.3%   17.3% 14.4%  
Interest (8) (8) 3.6% (15) (15) 1.4%
Depreciation - - - - - -
Profit before Tax 211 266 26.3% 349 477 36.5%
Extraordinary items - -   - - -
Tax 16 12 -26.5% 49 27 -44.5%
Profit after Tax/(Loss) 195 255 30.6% 300 450 49.7%
Net profit margin (%) 15.0% 17.8%   15.6% 16.5%  
No. of Shares 34.6 34.6   34.6 34.6  
Diluted Earnings per share* (Rs) 22.5 29.4   17.4 26.0  
P/E Ratio (x)   17.9     20.3  
* annualised            
** Includes depreciation and amortisation of ESOPs

Higher volume growth of 11% in the software services business has translated into a 6% rise in revenues sequentially. Also, MsourcE, the BPO unit witnessed a 19% growth in its revenues. The contribution of MsourcE to total revenues has now increased from 29% in 1QFY04 to 31% in this quarter. Growing revenue contribution from MsourcE is in line with the management’s objective.

On the hiring front, net additions have slowed down to 18 for MsourcE in 2QFY04. This is lower compared to 1QFY04 when the BPO division added 533 people in a single quarter. The total staff strength at MsourcE now stands at 3,138 and the company plans to take this tally to 4,000 by the end of FY04. For the software services business, the net addition to employees was 125. In 2QFY04, MphasiS added 5 new clients (12 in 1QFY04), including 1 (2 in 1QFY04) in MsourcE.

Improving efficiencies…
Operating margins* 2QFY03 3QFY03 4QFY03 1QFY04 2QFY04
Mphasis 21.0% 24.3% 25.5% 20.5% 20.4%
MsourcE 9.7% -3.0% -10.4% -3.8% 4.4%
Consolidated 18.9% 19.1% 16.4% 13.5% 15.3%
*includes depreciation

One of the most notable features of the September quarter results has been the positive shift that MsourcE has made on the operating margins front. From remaining negative during the past three quarters, the operating margins for the unit are now 4.4%. This is a likely result of the reduced level of hiring that MsourcE undertook during the quarter as well as strong growth in revenues from this division. Also, rationalization on the other expenses front helped the unit in improving upon its operational efficiency. While the improvement in the operating margins of MsourcE has been encouraging, the software division’s margins have shown a volatile movement in the last five quarters. While there has been margin improvement in the software division in FY03 the same has not been seen in FY04. This is a concerning aspect of the company’s performance.

Overall profitability of the consolidated entity has improved on account of reduced (as percentage of revenues) levels of employee and general costs. As percentage of revenues, while cost of revenues dropped from 71% in 1QFY04 to 68% in this quarter, general and administrative costs have declined marginally. Margins for 2QFY04 have also improved on account of higher utilization on MsourcE front (68%).

Net profits for MphasiS have also been boosted by reduced taxation liabilities and substantial increase in other income. The latter has improved substantially due to foreign exchange gains of Rs 32 m on account of hedging of receivables that the company undertook as a safeguard against the effects of an appreciating rupee.

At the current market price of Rs 534, the stock is trading at a P/E multiple of 20x its annualized 1HFY04 earnings. In absence of any announcement by management regarding its guidance, we believe that the earlier guidance of 30%-35% growth in revenues (100% growth in ITES revenues) and 40%-45% growth in profits stands. The fact that MsourcE’s margins have turned into the positive after remaining in the negative for the past three quarters implies that the group’s focus on the BPO segment has started to pay dividends. However, with large size orders still to come MphasiS’ way, optimism regarding the company’s performance in the future should be reserved. Investors need to apply caution and wait for some more time before the company displays positive performance on a sustainable basis.

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