The Hindu Business Line : MphasiS BFL: Hold

SHAREHOLDERS can stay invested in the MphasiS BFL stock. Factors such as the liquidity-driven price rally and the expected turnaround in pricing power of IT service companies suggest that it may not be prudent to pare exposures now.

Any share price appreciation over the next three months can be used to book profits partially.

However, fresh investments need not be contemplated in MphasiS BFL. The stock trades at a price-to-earnings multiple of about 20 times its earnings for the 12-month period ended September 2003.

The multiple requires an average growth rate of 30 per cent-plus in the next three years to generate modest price returns of about 15 per cent from present levels. This places the downside risk, owing to any setback in earnings growth, at a high level.

In addition, therupee movement needs to be watched keenly . Its continued appreciation spells trouble for IT companies such as MphasiS BFL.

Above expectations

MphasiS BFL packed a surprise for its investors when it unveiled an earnings growth of nearly 80 per cent on a consolidated basis. The major reason for the sharp rise in profitability were:

Eleven per cent improvement in volume of billed hours in software services;

Smaller rise in costs compared to the rise in revenue;

Higher contribution from gains on the foreign exchange forward contracts;

Lower incidence of tax due to tax credit for overseas entities;

Employee utilisation rates have improved in MsourcE but have remained stable at MphasiS.

However, as a guide to expected profit growth, the rise of 80 per cent in profits is misleading. This is because profit growth in the earlier quarters was suppressed because of large employee intake.

For example, in the quarter ended June 2003, MphasiS BFL's head count rose by 697. In contrast, the head count increased by a modest 143 in the quarter ended September 2003.

The lower head count rise ensured a lower rise in the cost of revenues in the quarter ended September 2003, producing an exaggerated impact on profitability.

Billing rates in both software services and business process outsourcing have remained stable. In addition, the management has itself not revised the guidance of 40-45 per cent in profit growth for the year-ended March 2004.

MsourcE stabilises

The limited employee intake in MsourcE, the business process outsourcing subsidiary of MphasiS BFL, is a major reason for the rise in profits.

Contrary to expectations that MsourcE will become profitable in the second half of 2003-04, it has become profitable this quarter itself.

MsourcE's profitability has vindicated the management's contention that when fresh investments taper off, the profitability of operations will improve. Profit margins are in single-digit now and can rise only if employee utilisation rates increase from the present level of 65 per cent.

However, the low employee intake in September 2003 of just 18 compared to above 500 in June 2003 may slow revenue growth. MsourcE registered quarterly revenue growth of about 20 per cent for many quarters now and that may come under pressure in the following quarter. If the increased acceptance of BPO globally is any indication, revenue growth of MsourcE is not under threat.

Still, the lower rise in employee intake is a minor cause for concern. The growth rate of 30 per cent plus in earnings in the next three years is predicated on MsourcE's growth. In this context, the employee intake at MsourcE in the next couple of quarters has to be watched keenly.

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