MphasiS' Q3FY18 results (Neutral) - Rev/Margin beat driven by HP business

Q3FY18 result highlights

• Strong operational performance: Revenue growth of 3.8% qoq to US$251.6m (IDFCe:US$ 245.2m) , led by growth in HP/DXC (3.2% qoq), while EBIT margin expanded by 104bps qoq to 15.5% (IDFCe: 14.3%) driven by lower SG&A. EPS grew by 7.8% qoq to Rs11.32 (IDFCe:Rs10.54). Hedging adjustment was at INR 390m in Q3FY18 as compared to 397m in Q2FY18. Growth was driven by bill rate increase in ITO (+12% QoQ  growth in onshore) and Application (+1% QoQ growth  onshore and 5% QoQ growth offshore)
• Both Direct and HP business showing traction: Direct International revenue grew on constant currency (cc) basis at 3.7% QoQ and 9.6% YoY. DXC/HP Revenue grew 3.6% QoQ and 20.5% YoY cc. DXC/HP business contributed 26% of the gross revenue for the Q3FY18. We were expecting some seasonal softness in HP, but both HP and Direct international have grown well. Deal signings momentum remains strong with additional US$130mn of deal wins, giving visibility. Total TCV stands at US$435m, up 58% yoy.
• Margin expansion a surprise: Bill rate improvement was driven by better product mix. However EBIT margins improved by lower S&M costs (7.2% of sales vs. 7.3% in Q2FY18). Additionally, Digital risk margins have improved to double digits aiding overall margins. There was a one-time impact of +40bps on the margins. Even adjusting for this margins, came in ahead of expectations.

Key positives: HP portfolio growth; deal closure

Key negatives: No gross margin expansion despite increase in bill rates

Impact on financials: FY18E/19E/FY20E EPS up by 3.5%/4.3%/5.6%.

Valuations & view

Strong quarter from Mphasis with continued outperformance in HP business. Moreover, strong deal closure yet again during the quarter improves revenue visibility further. We expect the USD revenue growth in high-single digit (9% CAGR FY19-20E). Revenue beat and raise in our EBIT margin assumption by 20-30bps for FY19-FY20 leads us to upgrade our EPS for FY19/FY20 by 4.3%/5.6%. We like the micro growth story of Blackstone portfolio and HP/DXC, but post the recent share price run up we see limited upside to re-rating (17x P/E FY19E). Retain Neutral, with revised target price of Rs790 (14.5x FY20E EPS) from Rs750.