Stock Review: MPHASIS

THE stock of Mphasis shot up by 8% on Tuesday in a falling market after it reported better-than-expected growth in net profit during the October 2010 quarter. However, the sequential profit growth of 4.7% during the quarter was aided by higher forex gains and lower tax outgo. Excluding these non-operating factors, operating profit grew by just over 2.7%. There is no visibility whether the growth would continue in the coming quarters as the company continues to struggle with higher attrition and sluggish growth in its non-HP business. Unlike its bigger peers, Mphasis reported lower sequential volume growth during the quarter, which is also the fourth quarter of its financial year. Its overall volume grew at just 4.8% as against the 7% growth in the previous quarter. The decline was on account of flat volumes in its BPO segment. The segment, which forms 12% of total revenue, is witnessing headwinds as its performance further deteriorated in the October quarter.

   The vertical-wise performance raises more concerns. The sequential growth in overall revenue is mainly driven by a strong 53% jump in revenue from the telecom vertical. Mphasis won a major client in the telecom space during the quarter and it had to face outage on one of the sites in the previous quarter. These factors led to the extraordinary growth in telecom revenue in the quarter. Revenues from its other major domains, including banking and financial services, manufacturing and retail, have either fallen or grown marginally. Mphasis is keen on improving its client base, most of which is through its relationship with HP. During the year ended October 2010, the client base through its direct channel has shrunk to 59 from 63 a year ago. On the contrary, clients through its HP channel have grown from 107 to 131 by similar comparison.

   At the end of the October quarter, Mphasis had 2,400 open billable employee positions. A portion of these positions is due to an above-average attrition rate. It has recorded 25-35% attrition across its divisions, much higher than 15-20% reported by its bigger peers.

   In the last few quarters, Mphasis has grown its business at a faster clip helped by its two acquisitions and the HP channel. Its stock currently trades at a trailing 12-month P/E of 12. Though this is cheap compared with its peers, the stock's performance would hinge on how effectively the company increases its direct channel presence and how well it tackles the higher employee attrition.