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Mphasis: Lower forex losses aid bottomline - Views on News from Equitymaster

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Mphasis: Lower forex losses aid bottomline
Oct 30, 2007

Performance summary
  • Topline grows 13% QoQ during 2QFY08, aided by growth in volumes and billing rates.

  • Operating margins contracts by 0.5% QoQ mainly due to rupee appreciation and salary hike given to 40% of employees; operating profits grow by 10% QoQ in 2QFY08.

  • PAT margins expands by 1.3% QoQ largely due to lower forex losses and higher operating profits.

Consolidated financial performance: A snapshot…
(Rs m) 1QFY08 2QFY08 Change 1HFY07 1HFY08 Change
Sales 5,316 6,017 13.2% 8,019 11,333 41.3%
Expenditure 4,338 4,938 13.8% 6,795 9,276 36.5%
Operating Profit 977 1,079 10.4% 1,224 2,056 68.0%
Operating Profit margin (%) 18.4% 17.9%   15.3% 18.1%  
Other income (147) (15)   31 (161)  
Depreciation 305 340 11.7% 451 645 43.1%
Profit before tax 526 724 37.7% 804 1,250 55.4%
Tax 13 61 374.1% 113 74 -34.7%
Profit after tax/(loss) 513 663 29.3% 692 1,176 70.1%
Net profit margin (%) 9.7% 11.0%   8.6% 10.4%  
No. of shares (m)         210.5  
Diluted earnings per share (Rs)*         8.0  
P/E ratio (x)*         37.5  
*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 it, things are expected to be better going forward.

What has driven performance in 2QFY08?
Volume growth drives business: Mphasis recorded a topline growth of 13% QoQ in 2QFY08 driven by volume growth in existing business coupled with addition of new clients. Blended rate improved by 3% QoQ during the quarter. Revenues from the banking & financial services vertical grew by 18% QoQ, with its contribution to total sales increasing to 45%, from 43% in 1QFY08. Revenues from BPO grew by 6% QoQ which was driven primarily from existing projects. Revenues from IT Outsourcing grew by 17% QoQ during 2QFY08. However, further strengthening of the rupee against the US dollar impacted the overall revenue growth during the quarter.

Revenue break up by
  1QFY08 2QFY08 Change
I. Geography % Share (Rs m) % Share (Rs m)  
USA 68% 3,615 67% 4,031 12%
Europe 18% 957 20% 1,203 26%
Asia Pacific 6% 319 5% 301 -6%
India and Middle East 8% 425 8% 481 13%
Total 100% 5,316 100% 6,017 13%
           
II. Verticals          
Banking and financial services 43% 2,286 45% 2,708 18%
Technology and OEMs 22% 1,169 23% 1,384 18%
Telecom 14% 744 12% 722 -3%
Manufacturing and retail 11% 585 10% 602 3%
Logistics, Airlines an Transporation 7% 372 7% 421 13%
Healthcare and Pharma 3% 159 3% 181 13%
Total 100% 5,316 100% 6,017 13%

Mphasis added a net of 2,008 employees during 2QFY08, with 1,146 added in applications, 731 in BPO and 131 in ITO Services, taking the total manpower to 24,078. On the client front, the company added 12 new clients during the quarter (9 came from EDS) and the total number of active clients now stands at 134.

Higher costs dents operating margins: Mphasis’ cost of revenues increased by 15% QoQ in 2QFY08 and it represented 76.3% of total revenues (74.9% in 1QFY08). The management has attributed this rise in costs of revenues to aggressive recruitment plans to build delivery capabilities, salary hikes, additional capacity build up for future growth and increase in cost of software tools and services. Selling expenses, however, declined from 4.6% of sales in 1QFY08 to 4.2% in 2QFY08. The appreciation in rupee shaved 1.4% off the operating margins.

Segmental Information
(Rs m) 1QFY08 2QFY08 Change
Application revenues 3,475 4,003 15.2%
% of total revenues 65.4% 66.5%  
PBIT margin (%) 26.6% 23.5%  
BPO revenues 1,244 1,314 5.6%
% of total revenues 23.4% 21.8%  
PBIT margin (%) 26.1% 23.7%  
IT outsourcing revenues 597 699 17.1%
% of total revenues 11.2% 11.6%  
PBIT margin (%) 14.9% 25.1%  

Lower forex losses help bottomline: Mphasis’ profit after tax increased by 29% QoQ during 2QFY08. Higher operating profits and lower foreign exchange losses resulted in this strong sequential rise in net profits during the quarter. The decrease in foreign exchange losses was primarily due to reduction in losses in forward contracts. The bottomline growth would have been higher but for an increase in the effective tax rate (from 2% in 1QFY08 to 8% in 2QFY08). The taxes have risen because the loss making foreign subsidiaries have turned profitable which resulted in reversal of deferred tax asset.

Performance over the past quarters
Performance over the past quarters 1QFY07 2QFY07 3QFY07 4QFY07 1QFY08 2QFY08
Sales growth (%, QoQ) 4.1 12.0 4.8 10.2 5.5 13.2
Cost of sales (% of sales) 76.2 38.9 69.4 68.9 74.9 76.3
Selling expenses (% of sales) 7.6 8.1 7.1 7.9 4.6 4.2
G&A expenses (% of sales) 9.7 9.5 9.4 8.8 7.8 7.1
EBITDA margins (%) 12.1 9.5 12.5 19.0 18.4 17.9
Profits growth (%, QoQ) -56.9 35.0 53.0 27.3 -18.4 29.3
Employees (Nos.)* 11,234 12,535 12,719 14,679 22,070 24,078

What to expect?
At the current price of Rs 300, the stock is trading at a multiple of 37.5 times its trailing 12 months earnings. The company, like its counterparts, is ramping up its activities in the infrastructure management space and plans to focus on this service in a big way going forward. The company has an order backlog of US$ 1 bn, which is to be executed within a period of 5 years. The company currently derives nil revenues from the subprime segment in US although it does some work in the prime segment in the banking vertical in US. Mphasis has had a volatile performance history but with EDS acquisition completed, things could shape up well for it going forward. We shall soon update our research report on the company.

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