March 5, 2018
Cognizant Technology Solutions (CTSH- NASDAQ) $82.27
Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 4Q17 Earnings Update
Prev. Ed.: Nov 30, 2017: 3Q17 Earnings Update
Firms’ Recommendations: Positive: 84% (21 firms); Neutral: 16% (4); Negative: 0.0% (0) Prev. Ed: 19, 5, 0
Firms’ Target Price: $89.25 (↑$5.25 from last edition; 20 firms) Firms’ Avg. Expected Return: 8.5%
Note: A flash update was done on Feb 7, 2018 (4Q17 Earnings Update)
*Note: Although dated Mar 5, 2018, share price and brokers’ material are of Feb 12, 2018
Note: The tables below (Revenues, Margins and EPS) contain material from fewer brokers than in the Valuation table. The extra figures in the Valuation table are taken from reports that did not have accompanying spreadsheet model.
Portfolio Manager Executive Summary
Cognizant Technology Solutions Corp. (CTSH or the company) is a leading provider of information technology, consulting, and business process outsourcing services. The company primarily serves four domains: Financial Services; Healthcare; Products and Resources; and Communications, Media and Technology. Cognizant reported revenues of $14.81 billion in FY17.
Key factors for evaluating an investment strategy for Cognizant are as follows:
Cognizant’s expertise in verticals like Financial Services and Healthcare is a positive Cash flow generation supports continuous investments Geographic and industry vertical concentration remains a concern
Competitive Position: Cognizant faces significant competition from the likes of Accenture, Capgemini, Computer Sciences Corp., Genpact, HCL Technologies, HP Enterprise, IBM Global Services, Infosys Technologies, Tata Consultancy Services, Wipro and numerous local providers.
Of the 25 firms covering the stock, 21 (84%) provided a positive rating, four (16%) provided neutral rating while none rendered a negative rating on the stock. Target prices range from a low of $79.00 to a high of $100.00, with the average being $89.25. The average expected return on the current share price is 8.5%.
Bullish (Buy or equivalent outlook) – 21 firms or 84% – These firms believe that Cognizant will benefit from its low wage resources. The company is able to offer competitive prices to its clients
© Copyright 2018, Zacks Investment Research. All Rights Reserved. because of its offshore presence where it can leverage lower cost resources. It also ensures that it has enough onshore presence to have a strong client relationship as well. This business model is allowing the company to increase its efficiency and maximize profits. Higher capital returns to investors is also a positive for the company. Strengthening insurance business along with double-digit growth in mid-tier banking bodes well for the company.
Cautious (Neutral or equivalent outlook) – 4 firms or 16% – These firms believe that since the company depends on low cost labor, appointing high skilled labor from other countries will be a problem under the new H1B visa rules. Thus, they might have to turn to high paid workers from onshore. Economic conditions and Forex uncertainties are also concerns. They are also wary about the company’s transition to highly volatile digital technologies and the company’s ability to maintain its top as well as bottom line targets. Moreover, the bribery scandal related to real estate contracts in India is an overhang on the company’s integrity and business model.
Mar 5, 2018
Overview
Headquartered in Teaneck, NJ, Cognizant Technology Solutions Corp. provides Consulting and Technology services and Outsourcing services. Its Consulting and Technology services comprise Business, Process, Operations and IT Consulting, Application Development and Systems Integration, Application Testing, Enterprise Information Management and Software Solutions and related services. Outsourcing services include Application Maintenance, IT Infrastructure Services and Business Process Services.
Cognizant reports operations under four segments: Financial Services (38.1% of 2017 revenues), Healthcare (28.8%), Products and Resources (20.5%) and Communications, Media and Technology (12.6%). The company’s majority development, delivery centers and technical professionals are located in India. Cognizant also has facilities in Europe, Asia Pacific, the Middle East and Latin America.
For more information, please visit its website: www.cognizant.com.
Note: Cognizant’s fiscal year ends on Dec 31.
Key investment considerations as identified by the analysts are as follows:
Key Positive Arguments Key Negative Arguments Cognizant is expected to benefit from offshore Cognizant operates in an intensely competitive IT outsourcing in the long run. services industry. Cognizant has strong growth potential from higher Longer-than-expected sales cycle pose a threat to demand of SMAC services in a number of the company’s growth rates. verticals. Industry and Geographical concentration are major The company has a strong balance sheet position headwinds. that places it well for pursuing strategic Restrictive visa legislation in the U.S. that could acquisitions. materially impact the company's ability to service Aggressive share buyback will boost EPS and clients with its low-cost labor pool and maintain shareholder value. margins.
Mar 5, 2018
Zacks Investment Research Page 2 www.zackspro.com Long-Term Growth
Cognizant is expected to continue to benefit from strong demand for high quality, lower cost technology services. Based on its global delivery model and expanding capacity in low cost areas in India, China, Philippines and Latin America, the company remains well-positioned in the outsourcing market. Long- term growth for the company is currently projected to be 12.6%.
Despite longer sales cycle, most of the firms believe that market growth remains healthy. The firms are of the opinion that growth in the coming years will be driven by verticals, where the company has had long-standing relationships with clients and is considered to be a clear market leader. Cognizant has also been capitalizing on financial services and health care. It has also been working to obtain in-depth industry knowledge through partnerships with leading firms in these domains. Most firms are positive on the company’s broad portfolio, stable margins, healthy cash flow and a top management team.
For the last few years, Cognizant has been increasing its focus toward high profit areas like professional consulting and business-process outsourcing. The company has also been gradually expanding its offerings in growth areas like social, mobile, analytics and cloud computing in order to get a more optimal business mix. Furthermore, the company is consistently developing its capabilities to benefit from the ongoing digital transition, especially when it comes to integration of the new digital framework with legacy technology platforms. Its new platform named Digital Works is designed to aid such business transformations. The firms believe that these emerging areas can become key growth drivers for the company going ahead.
Additionally, acquisitions have been a key growth catalyst for Cognizant. Acquisitions of Zone and Netcentrix are expected to expand its digital capabilities. The firms also believe that aggressive share buyback and likely dividend payment will further enhance shareholder value in the long run. Cognizant’s debt-free balance sheet positions it for tuck-in acquisitions. They believe that the strong cash flow position will help the company to continue its growth related investments over the long term.
Cognizant’s fast growing Financials and Healthcare segments are tailwinds. Most of the bullish firms believe higher demand from payer and top-tier consulting clients in the healthcare segment will help to sustain the growth momentum. The financial segment is expected to be driven by growth in insurance companies and regional banks, offsetting the headwinds arising from stringent spending from large banks. Besides, the firms expect its smaller segments like Products and Resources and Communications, Media, and Technology sector to be a key catalyst going ahead.
However, the company faces significant geographic and domain concentration risks amid stiff competition from peers, which can negatively impact its business. An additional concern for the company is the nature of its business, which necessitates bringing employees into the U.S. for on-site application maintenance work. With continuous pressure to avoid outsourcing and employment of foreign nationals, the U.S. government has reduced the number of H1-B visas granted each year. All these factors are forcing the company to employ U.S.-based workers at higher salaries, which can hurt its profitability, going forward.
Zacks Investment Research Page 3 www.zackspro.com Mar 5, 2018
Target Price/Valuation
Provided below is a summary of valuation and ratings as compiled by Zacks Research Digest:
Rating Distribution Positive 84.0%↑ Neutral 16.0%↓ Negative 0.0% Avg. Target Price $89.25↑ Highest Target Price $100.00↑ Lowest Target Price $79.00↑ No. of Analysts with Target Price/Total 20/25
According to the firms, principal risks to the target price include a sharp appreciation of the rupee against the U.S. dollar, large exposure to the financial services vertical, risk of a pullback in a still recovering global economy, deterioration of IT spending budgets, pricing pressure from other offshore peers, potential new U.S. visa limitations and more-than-expected salary and wage hikes coupled with high employee attrition.
Recent Events
On Feb 27, 2018, Cognizant announced that SoftBank Robotics Europe has selected it to provide Quality Engineering and Assurance (QE&A) services for the artificial intelligence (AI) systems in the Pepper and NAO robots.
On Feb 7, 2018, Cognizant announced the formation of a non-profit foundation that will foster growth of U.S. technology education with an initial investment of $100 million.
On Feb 7, 2018, Cognizant reported 4Q17 results. Highlights are as follows:
Non-GAAP EPS came in at $1.03. Revenues increased 10.6% y/y to $3.83 billion. Cash and cash equivalents (and short-term investments) were $5.06 billion.
Zacks Investment Research Page 4 www.zackspro.com Revenue
According to the 4Q17 press release, revenues grew 10.6% y/y to $3.83 billion.
Provided below is a summary of revenue as compiled by Zacks Digest:
Revenues ($ in 4Q16A 3Q17A 4Q17A 1Q18E 2Q18E 2017A 2018E 2019E Million)
Digest Average $3,462.0 $3,766.0 $3,828.0 $3,899.3 $4,025.1 $14,810.1 $16,226.0↑ $17,692.9↑ Digest High $3,462.0 $3,766.0 $3,828.0 $3,918.3 $4,040.0 $14,811.3 $16,295.0 $17,898.7↑ Digest Low $3,461.9 $3,766.0 $3,828.0 $3,876.0 $4,013.1 $14,810.0 $16,150.9↑ $17,369.3↑ Y/Y Growth 7.1% 9.1% 10.6% 10.0% 9.7% 9.8%↑ 9.6%↑ 9.0%↑ Q/Q Growth 0.3% 2.6% 1.6% 1.9% 3.2%
Segment-wise, Financial services (37.3% of revenues), which includes insurance, banking and transaction processing, grew 5.4% y/y to $1.43 billion. The segment was driven by double-digit growth in insurance companies and mid-tier banks, which offset the softness arising from large banks.
Healthcare (29.4% of revenues) grew 11.9% y/y to $1.09 billion. Top-line growth was driven by steady demand across payer clients and increasing interest in the company’s digital, analytics, cloud and virtualization solutions.
Products and Resources (20.4% of revenues) continued its growth momentum and improved 13.7% y/y to $782 million driven by growth in manufacturing, logistics, energy and utilities clients.
Communications, Media and Technology (12.9% of revenues) were $494 million, up 19% y/y.
Region-wise, revenues from North America increased 8.5% y/y and represented 77% of total revenues.
Revenues from the United Kingdom increased (7.5% of revenues) 5.1% y/y. Rest of Europe continued to show strength with revenues surging 31.7% y/y. As a result, Europe revenues increased 18.1% y/y to $632 million.
Rest of the World (6.5% of revenues) advanced 17.5% to $249 million y/y.
Provided below is a summary of Segment revenue as compiled by Zacks Digest:
Segment Revenue ($ 4Q16A 3Q17A 4Q17A 1Q18E 2Q18E 2017A 2018E 2019E in million) Financial Services $1,354.0 $1,427.0 $1,427.0 $1,469.4 $1,512.0 $5,636.0 $6,058.2↓ $6,522.5↓
Healthcare $1,005.0 $1,085.0 $1,125.0 $1,111.9 $1,158.3 $4,263.0 $4,678.6↑ $5,060.0↑
Products and Resources $688.0 $774.0 $782.0 $812.1 $828.4 $3,040.0 $3,350.1 $3,636.9↓ Communications, Media and $415.0 $480.0 $494.0 $494.6 $524.9 $1,871.0 $2,103.3↑ $2,302.7↑ Technology
Zacks Investment Research Page 5 www.zackspro.com Guidance
For 1Q18, Cognizant expects revenues in the range of $3.88-$3.92 billion.
For FY18, revenues are now expected to be in the range of $16.00-$16.30 billion.
Firms’ Outlook
The bullish firms believe that Cognizant’s large exposure to financial service and health care is a positive. Growth in the company’s Products & Resources segment along with its Communications, Media and Technology segments is also anticipated to boost its top line going forward.
The company is well-poised to benefit from the rise in global offshore IT services. The firms believe that work performed offshore could generate cost savings and since Cognizant has large exposure to low cost markets, it is well positioned to benefit from this trend. Key drivers of growth include cost efficiencies and enhanced flexibility for clients.
However, continuous decline in the retail vertical is a headwind. Besides, appointing high skilled labors from other countries is a concern under the new H1B visa norms. The firms are also apprehensive regarding the improvement of spending by large banks, which is currently an overhang on the financial sector. In the healthcare segment, uncertainty regarding the Affordable Care Act is a concern.
Please refer to the Zacks Research Digest spreadsheet on CTSH for more details on revenue.
Margins
According to the 4Q17 press release, as a percentage of revenues, SG&A contracted 280 basis points (bps) on a y/y basis to 18.3%. Non-GAAP operating margin of 19.7% expanded 100 bps from the year- ago quarter.
Provided below is a summary of margins as compiled by Zacks Digest:
Margins 4Q16A 3Q17A 4Q17A 1Q18E 2Q18E 2017A 2018E 2019E Gross 40.4% 38.3% 38.7% 39.1% 39.2% 38.6% 38.9%↑ 39.4%↑ Operating 18.7% 20.0% 19.7% 20.5% 20.9% 19.7% 20.9%↑ 21.9%↑ Pre tax 18.8% 20.4% 20.9% 21.3% 21.6% 20.7% 21.6%↑ 22.6%↑ Net 15.3% 15.4% 15.9% 16.0% 16.3% 15.2% 16.4%↑ 16.8%↑
Firms’ Outlook
Most of the bullish firms expect margins to improve given the company’s strategy to lower hiring. Growth in digital revenues, company’s structural realignment program, capital return policy and industry tailwinds are also anticipated to improve margins.
However, a few firms believe increasing investment owing to ongoing development strategies will weigh on margins.
Zacks Investment Research Page 6 www.zackspro.com Per the Zacks Digest model, SG&A expense is expected to increase at a slower rate against revenue growth in FY18 (3.3% versus 9.6%) as well as in FY19 (6.3% versus 9.0%).
D&A expense is also expected to grow at a slower rate compared with revenue growth in FY18 (7.1% versus 9.6% growth) and FY19 (5.2% versus 9.0%).
Please refer to the Zacks Research Digest spreadsheet on CTSH for more details on margins.
Earnings per Share
According to the 4Q17 press release, Cognizant’s non-GAAP EPS was $1.03, up 18.4% from the year- ago quarter.
Provided below is a summary of EPS as compiled by Zacks Digest:
EPS 4Q16A 3Q17A 4Q17A 1Q18E 2Q18E 2017A 2018E 2019E Digest Average $0.87 $0.98 $1.03 $1.06 $1.12 $3.77 $4.55↑ $5.18↑ Digest High $0.87 $0.98 $1.03 $1.10 $1.13 $3.79 $4.56↑ $5.28↑ Digest Low $0.87 $0.97 $1.03 $1.04 $1.11 $3.77 $4.52↑ $5.08 ↑ Y/Y Growth 8.7% 13.8% 18.4% 26.7% 20.7% 9.5% 20.4%↑ 13.9%↓ Q/Q Growth 1.1% 5.5% 5.3% 3.2% 5.3%
Guidance
For 1Q18, non-GAAP EPS is expected to be at least $1.04. For FY18, the company projects non-GAAP EPS to be at least $4.53.
Firms’ Outlook
Some firms believe that unexpected deceleration in revenue growth along with some economic fluctuations and Forex uncertainties can be probable headwinds. Nevertheless, firms believe that the U.S. tax reform will have a positive impact on EPS. A disciplined expenditure structure, margin expansion, share repurchase initiatives and an improving macro environment will boost EPS going forward.
Please refer to the Zacks Research Digest spreadsheet on CTSH for more details on EPS.
Research Analyst Madhura Bhattacharyya
Copy Editor Tuhin Roy
Content Ed. QCA Aniruddha Ganguly
Lead Analyst
Reason for Update 4Q17 Earnings Update
Zacks Investment Research Page 7 www.zackspro.com