>MPHASIS: Overweight(V): 2QFY10 preview – low downside risk

Pricing remains the unknown, but downside risk is low: The key question for the
investors currently is whether the pricing discounts seen in 1Q were one-off and limited to the
Infra (ITO) division. We do not rule out further pricing discounts (in both the Applications
and ITO divisions). However, we believe management has defined benchmarks for
profitability and may not be willing to win business that breaches its profitability criteria. We
have factored in 31%-30% threshold gross margins for the Applications and ITO divisions in
our forecasts (which implies further pricing discounts in FY10).

However, expect volume growth to remain robust: We expect robust volume growth in FY10/11 (+34%/+22% y-o-y), as its parent (Hewlett Packard, HPQ.N, USD46.58, not rated) continues to increase offshoring in its existing business. We see HP facing increasing pressure to retain its market share in the global IT services market due to growing offshore demand and mid-term restructuring of mega-deals.

2QFY10: We expect 4.5% q-o-q USD top-line growth and an EBITDA margin decline of c100bps sequentially (primarily driven by our assumption of a pricing discount in the Application division and INR appreciation). We expect EPS of INR11.8.

Valuations undemanding: The stock is currently trading at 13x our FY10e EPS. We expect strong volume growth in FY10 and FY11 and EPS growth of c8% in FY11 (despite a material increase in the tax rate). We value the stock at a PE of 14.5x on our FY11e EPS, which is a 35% discount to Infosys (INFY.BO, INR2,581, OW). We remain OW(V) on MphasiS with a target price of INR770.

To read the full report: MPHASIS