Mphasis' Q4FY18 results (Upgrade to Outperformer) - Another strong quarter with Rev/Margin beat.

Q4FY18 result highlights

• Strong operational performance: Revenue growth of 4.4% cc qoq to US$264m (IDFCe:US$ 256.9m) , led by growth in HP/DXC (8.3% cc qoq), while EBIT margin expanded by 130bps qoq to 16.8% (IDFCe: 15.5%) driven by lower SG&A and 50bps impact of one-time India revenue. EPS grew by 10.5% qoq to Rs12.4 (IDFCe:Rs11.55). Hedging adjustment was at Rs412m in Q4FY18 as compared to Rs390m in Q3FY18. Growth was driven by bill rate increase in ITO (+10% QoQ  growth in onshore) and Application (+1.2% QoQ growth  onshore)
• HP business traction continues: Direct International revenues grew on constant currency (cc) basis at 2.5% qoq and 12.7% yoy. DXC/HP revs grew 8.3% qoq and 29.5% yoy cc. DXC/HP business contributed 26% to revenues in Q4FY18. Management outlook is positive with company expecting Direct International to growth faster than industry and even HP/DXC channel should be atleast at industry average. Deal signings momentum remains good with additional US$116mn of deal wins, giving visibility. Total TCV stands at US$551m, up 51% yoy.
• Margin expansion continued with raised target band: EBIT margins improved led by better gross margins and lower S&M costs (5.8% of sales vs. 7.3% in Q2FY18). Even adjusted for ~50bps one-off margin tailwind, there has been 100bps operational improvement qoq. Importantly the target margin band for FY19 has been raised by 100bps to 15-17%.

Key positives: HP portfolio growth; deal closure

Key negatives: Direct international growth trailing HP/DXC

Impact on financials: FY19E/FY20E EPS up by 5%/9%.

Valuations & view

Another strong quarter from Mphasis with continued outperformance in growth and margins. Moreover, the FY19 outlook is strong for both growth and margins. We expect the USD revenue growth to be better than industry (11% CAGR FY19-20E). Revenue beat and raise in our EBIT margin assumption by 100bps for FY19E-FY20E leads us to upgrade our EPS for FY19E/FY20E by 5%/9%. We have liked the micro growth story of Blackstone portfolio and HP/DXC; and strong FY19 commentary and margin delivery gives us more confidence on business execution. This leads us to upgrade our rating from Neutral to Outperformer. We revise target price to Rs1060 (18x FY20E EPS-inline with MTCL) from Rs790.